Suppose We Observe the Following Rates: ₁R₁ = 8 Percent

question 44

Multiple Choice

Suppose we observe the following rates: ₁R₁ = 8 percent, ₁R₂ = 10 percent, and E(₂r₁) = 8 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L₂?

• A) 1.02 percent
• B) 4.04 percent
• C) 6.15 percent
• D) 12.03 percent