Several major theories have been developed to explain the term structure of interest rates and the resulting yield curve: • Expectations theory suggests forward interest rates are representative of expected future interest rates. As a result, the shape of the yield curve and the term structure of rates are reflective of the market’s aggregate expectations.

• Liquidity theory suggests that investors will choose longer term maturities if they are provided with additional yield that compensates them for lack of liquidity. As a result, liquidity theory supports that forward interest rates possess a liquidity premium and an interest rate expectation component.

• Preferred habitat hypothesis suggests that investors who usually prefer one maturity horizon over another can be convinced to change maturity horizons given an appropriate premium. This suggests that the shape of the yield curve depends on the policies of market participants.

• Market segmentation theory suggests that different investors have different investment horizons that arise from the nature of their business or as a result of investment restrictions. These prevent them from dramatically changing maturity dates to take advantage of temporary opportunities in interest rates. Companies that have a long investment time horizon will therefore be less interested in taking advantage of opportunities at the short end of the curve.