If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be
A) flat
B) downward sloping.
C) upward sloping.
D) none of the above.

Question

Quizplus · Accepted Answer

According to the liquidity premium theory, long-term bonds will have higher yields compared to short-term bonds due to the added risk and uncertainty of holding them for a longer period. This would result in an upward-sloping yield curve. Therefore, option C) is the best choice.

If the Liquidity Premium Theory Completely Describes the Term Structure