According to the liquidity premium theory of the term structure, A. the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a liquidity premium. B. buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of different maturities move together over time. C. even with a positive liquidity premium, if future short-term interest rates are expected to fall significantly, then the yield curve will be downward-sloping. D. all of the above. E. only A and B of the above.

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22-06-2021
Business

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According to the liquidity premium theory of the term structure, A. the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a liquidity premium. B. buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of different maturities move together over time. C. even with a positive liquidity premium, if future short-term interest rates are expected to fall significantly, then the yield curve will be downward-sloping. D. all of the above. E. only A and B of the above.

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Parrain Parrain · Answer 1 · 2021-06-25T03:20:55+02:00

Answer: D. all of the above.

Explanation:

The liquidity premium is the amount that is added to the interest rate in order to compensate investors for buying longer term and less liquid securities. This is why the interest rates on log-term bonds include a liquidity premium.

It is true that depending on preference, buyers of bonds prefer to buy one maturity over another but overall, the interest rates on different maturities move together in that an increase in the short term would see an increase in the long term.

Even if the liquidity premium is positive in order to compensate investors for longer maturities, it would not be enough to pull the interest rates up if they are falling significantly which would lead to a downward - sloping yield curve.