The Liquidity Premium Theory of the Term Structure of Interest

question 43

Multiple Choice

The liquidity premium theory of the term structure of interest rates:

• A)assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long term.
• B)assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium.
• C)recognises that forward rates are perfect predictors of future interest rates.
• D)assumes that risk premiums increase uniformly with maturity.

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Definitions:

Initial Investment

Refers to the initial amount of money invested in a project, business venture, or asset, serving as the baseline for future return analysis.

Cash Inflows

The total amount of money being transferred into an entity, typically measured over a certain period and arising from operational, investment, and financing activities.

IRR

Internal Rate of Return, a financial metric used to estimate the profitability of potential investments by calculating the interest rate at which the net present value of all cash flows (both positive and negative) from a particular project equals zero.

Required Rate

The minimum return needed from an investment to compensate for its risk.