If the Liquidity Premium Theory Completely Describes the Term Structure

question 6

Multiple Choice

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.

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Definitions:

Yield Curve

The yield curve is a graphical representation of the interest rates on debt for a range of maturities, showing the relationship between interest rates and the time to maturity.

Semiannually

Occurring twice a year; typically used in finance to describe payments, compounding interest, or other events that happen every six months.

Market Rate of Interest

The prevailing rate of interest determined by supply and demand in the money market, influencing the cost of borrowing or the return on investment.

Coupon

The interest paid yearly on a bond, indicated as a percentage of the bond's original value.