The liquidity premium theory of the term structure of interest rates
A)assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term.
B)assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium.
C)recognizes that forward rates are perfect predictors of future interest rates.
D)assumes that risk premiums increase uniformly with maturity.

Question

Quizplus · Accepted Answer

The liquidity premium theory suggests that investors require a premium or compensation to invest in long-term bonds to compensate for the uncertainty associated with holding the bonds for an extended period. Therefore, investors may require a higher yield or interest rate to hold longer-term bonds.

The Liquidity Premium Theory of the Term Structure of Interest