According to the liquidity premium theory of the term structure
A)bonds of different maturities are not substitutes.
B)if yield curves are downward sloping,then short-term interest rates are expected to fall by so much that,even when the positive term premium is added,long-term rates fall below short-term rates.
C)yield curves should never slope downward.
D)interest rates on bonds of different maturities do not move together over time.

Question

Quizplus · Accepted Answer

The liquidity premium theory suggests that long-term rates incorporate a term premium, which compensates investors for holding long-term bonds. This term premium is positive in most cases, meaning that long-term rates are higher than short-term rates. However, if the yield curve is downward sloping, it means that short-term rates are expected to fall so much that even when the positive term premium is added, long-term rates will still be lower than short-term rates. This is seen as an abnormal situation and indicates market expectations for a significant decline in short-term rates. Therefore, option B is correct, while options A, C, and D are incorrect.

According to the Liquidity Premium Theory of the Term Structure