What is liquidity premium theory about interest rate? Can it be used to explain the downward-sloping...

What is liquidity premium theory about interest rate? Can it be used to explain the downward-sloping yield curve?

Expert Solution

A major concept used in investment in bonds is liquidity premium theory of interest rate. This theory helps to understand the yield curve which is made up of different interest rates with different maturities.

This theory is majorly used in the area where the sale of bond can be done as soon as possible without compromising specified bond price.

According to liquidity premium theory, investor always seek for the short-term asset which can be sold in short period of time over long term assets.

Liquidity premium theory also argues that compensation to the investor must be available against risk of changes in price because of change in interest rate.

Yield curve represents the combination of different interest rates with different maturity time periods. Downward sloping yield curve represents that investor believes that interest rate will fall in future. As a result, today investor starts investing more in short term assets to get higher yields.

jeff jeffy answered 4 hours ago

According to the liquidity premium theory of the term structure, a) the interest rate for each...

According to the liquidity premium theory of the term structure, a) the interest rate for each maturity bond is determined by supply and demand for that maturity bond. b) 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. c) because of the positive term premium, the yield curve will not be observed to be downward sloping. d) the interest rate on long-term bonds will...

Explain the critically discuss liquidity preference theory of interest. Can interest rate by zero. Give reason...

Explain the critically discuss liquidity preference theory of interest. Can interest rate by zero. Give reason for your answer.

What will the investor say about the future change of interest rate according to liquidity preference theory?

Suppose an investor observes a downward term structure of interest rate. What will the investor say about the future change of interest rate according to liquidity preference theory? Explain your argument. (10 marks)

4 Liquidity premimum theory, Use the liquidity premium theory to explain how the quantitative easing policy...

4 Liquidity premimum theory, Use the liquidity premium theory to explain how the quantitative easing policy implemented from 2009-2014 and the forward guidance policy at that time affect the long term interest rate.

Explain why demand curve are downward sloping

According to the liquidity premium theory of interest rates, Tell me the letter of the correct...

According to the liquidity premium theory of interest rates, Tell me the letter of the correct answer to the question below AND tell me why the other answers are incorrect. * According to the liquidity premium theory of interest rates, * A. Long term spot rates are totally unrelated to expectations of future short-term rates. B.Long-term spot rates are higher than the average of current and expected future short-term rates. C.Investors are indifferent between different maturities if the long-term spot...

What is the liquidity premium theory? How does this theory combine the features of pure expectations...

What is the liquidity premium theory? How does this theory combine the features of pure expectations theory and market segmentation theory? What are the implications of the same?

What are the three effects that explain why AD curve is downward sloping and the two...

What are the three effects that explain why AD curve is downward sloping and the two effects that explain why AS curve is upward sloping? Explain the Real Balance effect and the Foreign Trade effect in detail.

1. For this question, assume the liquidity premium theory. a. What is the major difference in...

1. For this question, assume the liquidity premium theory. a. What is the major difference in the assumption about the risk premium between the expectations hypothesis and the liquidity premium theory? b. Assuming that all future expected short-term interest rates on treasury bills are 2%, determine if the three year treasury note has an annual interest rate of greater or less than 2%. Explain. c. Commercial paper with maturity of one year is issued by Amazon. Is the annual interest...

how does the theory of the liquidity preference explain downward-slopping aggregate demand curve? Explain your answer...

how does the theory of the liquidity preference explain downward-slopping aggregate demand curve? Explain your answer in both words and diagrams.

Question