Question

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 rates are equal to the average of current and expected future short-term rates.

D. Investors prefer certain maturities and will not normally switch out of those maturities

E. The term structure must always be upward sloping

Answer 1

Option B is correct

.Long-term spot rates are higher than the average of current and expected future short-term rates.

Longer term bonds have lower liquidity so it has liquidity premium associated with it, so short term spot rates are less than longer-term rates