According to the Liquidity Premium Theory of the Term Structure

question 35

Multiple Choice

According to the liquidity premium theory of the term structure,

• A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a liquidity premium.
• B) buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of different maturities move together over time.
• C) even with a positive liquidity premium, if future short-term interest rates are expected to fall significantly, then the yield curve will be downward-sloping.
• D) all of the above.
• E) only A and B of the above.

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Definitions:

Simple Interest

Interest calculated solely on the principal amount of a loan or deposit, without compounding.

Consecutive GICs

A sequence of Guaranteed Investment Certificates held one after another, often to create a ladder strategy for managing interest rate risk.

Interest Rates

The amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets.

Term Deposit

A bank deposit that has a fixed term or period of time until you can access your money, often with a higher interest rate than savings accounts.