Canadian Securities Course (CSC) Level 1 Practice Exam

Describe the market segmentation theory.

1. Bonds with different maturities have different demand and supply dynamics

2. Bonds with different coupon rates have different yield curves

3. Bonds with different risk profiles have similar prices

4. Bonds with different issuers behave identically

The correct answer is: Bonds with different maturities have different demand and supply dynamics

The market segmentation theory posits that the bond market is divided into distinct segments based on the maturity of the bonds. According to this theory, investors have specific preferences for bonds of varying maturities due to different investment goals, risk tolerances, and liquidity needs. Consequently, the demand and supply dynamics for bonds can vary significantly across these maturity segments. This theory allows for the possibility that interest rates on bonds of different maturities can behave differently, influenced by the specific demand and supply conditions within each segment. Such differentiation in demand and supply can lead to varying interest rates and yield curves based on maturity rather than on a unified approach, validating the point made in the answer regarding the differing demand and supply dynamics for bonds with varying maturities. The other choices do not accurately reflect the core premise of market segmentation theory. For instance, while coupon rates may influence yield curves, this is less about market segmentation and more about pricing mechanisms across the whole market. Similarly, the comparison of risk profiles and issuer behavior does not specifically address the segmentation aspect that the theory emphasizes.