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:

Liquidity

Refers to the ease with which assets can be converted into cash without significant loss of value.

Asset Management

The systematic process of developing, operating, maintaining, and selling assets in a cost-effective manner.

Debt Financing

The raising of funds through borrowing, typically by issuing bonds or taking out loans, as opposed to equity financing.

Liquidity

The ease with which an asset can be converted into cash without significantly affecting its market price.