What can you deduce about forward rates of interest if the liquidity-preference hypothesis of the term structure is correct?
A) The forward rate is less than investor's expectations of next year's one-year interest rate.
B) The forward rate is greater than investor's expectations of next year's one-year interest rate.
C) The forward rate is equal to investor's expectations of next year's one-year interest rate.
D) The forward rate is equal to the risk-free interest rate.

Question

Quizplus · Accepted Answer

The liquidity-preference hypothesis suggests that investors demand a premium for holding longer-term bonds, implying that forward rates are higher than what investors actually expect future short-term rates to be. This is because investors perceive longer-term investments as riskier and demand a higher return for committing their money for a longer period.

What Can You Deduce About Forward Rates of Interest If