The liquidity premium theory can generate a downwards sloping yield curve if investors expect:
A)a large increase in future interest rates.
B)a small increase in future interest rates.

Question

Quizplus · Accepted Answer

The liquidity premium theory states that investors require a higher return for holding longer-term bonds because of the uncertainty of future interest rates. If investors expect a large increase in future interest rates, they will demand a higher liquidity premium for holding longer-term bonds, which will result in a downwards sloping yield curve.

The Liquidity Premium Theory Can Generate a Downwards Sloping Yield