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Preferred habitat theory

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Definition of Preferred habitat theory

Preferred Habitat Theory Image 1

Preferred habitat theory

A biased expectations theory that believes the term structure reflects the
expectation of the future path of interest rates as well as risk premium. However, the theory rejects the
assertion that the risk premium must rise uniformly with maturity. Instead, to the extent that the demand for
and supply of funds does not match for a given maturity range, some participants will shift to maturities
showing the opposite imbalances. As long as such investors are compensated by an appropriate risk premium
whose magnitude will reflect the extent of aversion to either price or reinvestment risk.



Related Terms:

Market segmentation theory or preferred habitat theory

A biased expectations theory that asserts that the
shape of the yield curve is determined by the supply of and demand for securities within each maturity sector.


Expectations hypothesis theories

Theories of the term structure of interest rates which include the pure
expectations theory, the liquidity theory of the term structure, and the preferred habitat theory. These theories
hold that each forward rate equals the expected future interest rate for the relevant period. These three theories
differ, however, on whether other factors also affect forward rates, and how.
Expectations theory of forward exchange rates A theory of foreign exchange rates that holds that the
expected future spot foreign exchange rate t periods in the future equals the current t-period forward exchange
rate.


Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.


Agency theory

The analysis of principal-agent relationships, wherein one person, an agent, acts on behalf of
anther person, a principal.


Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.



Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.


Bubble theory

Security prices sometimes move wildly above their true values.


Preferred Habitat Theory Image 2

Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.


Convertible preferred stock

preferred stock that can be converted into common stock at the option of the holder.


Cost of Preferred Stock

The rate of return required by the investors in the preferred stock of
a company. A component of the cost of capital.


Cumulative preferred stock

preferred stock whose dividends accrue, should the issuer not make timely
dividend payments. Related: non-cumulative preferred stock.


expectations theory of exchange rates

theory that expected spot exchange rate equals the forward rate.


Floating-rate preferred

preferred stock paying dividends that vary with short-term interest rates.


Liquidity theory of the term structure

A biased expectations theory that asserts that the implied forward
rates will not be a pure estimate of the market's expectations of future interest rates because they embody a
liquidity premium.


Local expectations theory

A form of the pure expectations theory which suggests that the returns on bonds
of different maturities will be the same over a short-term investment horizon.


Modern portfolio theory

Principles underlying the analysis and evaluation of rational portfolio choices
based on risk-return trade-offs and efficient diversification.


Preferred Habitat Theory Image 3

Monthly income preferred security (MIP)

preferred stock issued by a subsidiary located in a tax haven.
The subsidiary relends the money to the parent.


Non-cumulative preferred stock

preferred stock whose holders must forgo dividend payments when the
company misses a dividend payment.
Related: Cumulative preferred stock



Normal backwardation theory

Holds that the futures price will be bid down to a level below the expected
spot price.


pecking order theory

Firms prefer to issue debt rather than equity if internal finance is insufficient.


Preferred Beneficiary

Used in older contracts to confer the same rights as an irrevocable beneficiary. Applied to family members.


Preferred equity redemption stock (PERC)

preferred stock that converts automatically into equity at a
stated date. A limit is placed on the value of the shares the investor receives.


Preferred Rates

As non-smoking rates caused a major reduction in the cost of life insurance in the early 1980's, the emergence of preferred non-smoker rates in 1998 has caused another noteworthy reduction in rates. A growing number of insurance companies are offering better rates which go beyond simply looking at gender or smoking habits. Other health related factors such as physical build, lifestyle, avocation and personal and family health history indicating longer life expectancy can add up to significant cost savings to new life insurance applicants. Make certain to ask about these new preferred rates.


Preferred shares

preferred shares give investors a fixed dividend from the company's earnings. And more
importantly: preferred shareholders get paid before common shareholders. See: preferred stock.


Preferred Shares

Are equity instruments that take no security against assets, have flexible terms of repayment and pay fixed or floating dividends.


Preferred stock

A security that shows ownership in a corporation and gives the holder a claim, prior to the
claim of common stockholders, on earnings and also generally on assets in the event of liquidation. Most
preferred stock pays a fixed dividend that is paid prior to the common stock dividend, stated in a dollar
amount or as a percentage of par value. This stock does not usually carry voting rights. The stock shares
characteristics of both common stock and debt.


Preferred Stock

A type of equity security where holders have a claim on the assets
and earnings of a company after the debt providers but before the
holders of common stock. preferred stock generally pays a fixed
or floating rate dividend each year.


Preferred Habitat Theory Image 4

Preferred stock

A type of stock that usually pays a fixed dividend prior to any distributions
to the holders of common stock. In the event of liquidation, it must be paid
off before common stock. It can, but rarely does, have voting rights.



preferred stock

Stock that takes priority over common stock in regard to dividends.


Preferred stock agreement

A contract for preferred stock.


Preferred Stock Stock that has a claim on assets and dividends of a corporation that are prior

to that of common stock. preferred stock typically does not carry the right to vote.


Pure expectations theory

A theory that asserts that the forward rates exclusively represent the expected
future rates. In other words, the entire term structure reflects the markets expectations of future short-term
rates. For example, an increasing sloping term structure implies increasing short-term interest rates. Related:
biased expectations theories


Quantity Theory of Money

theory that velocity is constant, and so a change in money supply will change nominal income by the same percentage. Formalized by the equation Mv = PQ.


random walk theory

Security prices change randomly, with no predictable trends or patterns.


Real Business Cycle Theory

Belief that business cycles arise from real shocks to the economy, such as technology advances and natural resource discoveries, and have little to do with monetary policy.


Redeemable Preferred Stock

A preferred stock issue that must be redeemed by the issuing enterprise or is redeemable at the option of the investor. Considered a debt security for accountingpurposes.


Static theory of capital structure

theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.


theory of constraints (TOC)

a method of analyzing the bottlenecks
(constraints) that keep a system from achieving
higher performance; it states that production cannot take
place at a rate faster than the slowest machine or person
in the process


trade-off theory

Debt levels are chosen to balance interest tax shields against the costs of financial distress.



 

 

 

 

 

 

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