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.
E)None of the above.

Question

Quizplus · Accepted Answer

The liquidity premium theory assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term. This means that investors require a higher rate of return for longer-term assets to compensate for the risk of holding them for a longer period.

The Liquidity Premium Theory of the Term Structure of Interest