Suppose We Observe the Following Rates: ₁R₁ = 13 Percent

question 32

Multiple Choice

Suppose we observe the following rates: ₁R₁ = 13 percent, ₁R₂ = 16 percent, and E(₂r₁) = 10 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L₂?

• A) 8.7 percent
• B) 9.1 percent
• C) 9.7 percent
• D) 10.0 percent