Behaviour Of Markets

Question 1

Anti-selection

Answer 1

People are more likely to take out contracts when they believe their risk is higher than the insurance company has allowed for in its premiums

Question 2

Moral hazard

Answer 2

Risk that an insured may attempt to take an unfair advantage of the insurer, for example by suppressing information relevant to the assessment of risk or by submitting a false claim

Question 3

the four theories of yield curve

Answer 3

Market segmentation theory:
the shape of the yield curve will reflect the relative impact of supply and demand at various durations along the curve

liquidity preference:
an upward sloping yield reflects investor’s preference for less volatile shorter dated bonds

expecation theory:
shape of real yield curve is determined by economic factors which drive invetor’s expectations of short-term real interest rates in the future

risk premium theory:
investors require an additional yield on additional yield on longer term conventional bonds to compensate for the risk of inflation being higher than anticipated

Question 4

why might a yield curve be downwards sloping

Answer 4

may believe that short term rates are expected to decrease going forward

investor demand for long bonds may be higher

government may prefer issuing short term bonds - increasing supply at the shorter end of the yield curve relateive to the longer end

the market segmentation theory is more compensating than liquidity preference