According to the liquidity premium theory of the term structure,
A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time.
B) 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 term premium.
C) because of the positive term premium, the yield curve cannot be downward-sloping.
D) all of the above.
E) only A and B of the above.

Question

Quizplus · Accepted Answer

The liquidity premium theory of the term structure states that the interest rate on a long-term bond is equal to an average of short-term interest rates that people expect to occur over the life of the long-term bond plus a term premium. Option A is incorrect because the theory does not state that interest rates on bonds of different maturities do not move together over time. Option C is incorrect because the term premium can be negative, resulting in a downward-sloping yield curve.

According to the Liquidity Premium Theory of the Term Structure