Chartered Alternative Investment Analyst Association (CAIA) Exam 2025 – 400 Free Practice Questions to Pass the Exam

The unbiased expectations theory suggests that the term structure of interest rates reflects the market's expectations of future interest rates and that investors expect to earn the same return on bonds of different maturities. According to this theory, any differences in yields across various maturities are attributed solely to the expectations of future short-term interest rates. Essentially, if an investor is indifferent between holding a long-term bond versus a series of short-term bonds, it implies that there would be no risk premium associated with the term structure, leading to the conclusion that all bonds should have similar expected returns when adjusted for the time value of money.

This theory emphasizes that the yield curve is a reflection of future interest rate movements anticipated by investors. As a result, if one segment of the yield curve is higher than another, investors would expect that the shorter-term bonds would yield less than longer-term bonds over the investment horizon, which maintains the premise that expected returns across various bonds converge.

In contrast, liquidity preference theory posits that investors require a premium for holding longer-term securities due to their increased risk of interest rate fluctuations, while the preferred habitat theory allows for different maturities being more favorable for certain investors based on their specific needs. Market segmentation theory suggests that different investor segments have preferences for different matur