If expected future short-term interest rates are equal to current short-term rates, the liquidity premium will
A)make long-term rates lower than current short-term rates.
B)make long-term rates higher than current short-term rates.
C)make long-term rates equal to current short-term rates.
D)make have no effect.

Question

Quizplus · Accepted Answer

The liquidity premium theory suggests that long-term interest rates not only reflect investors' assumptions about future interest rates but also include a premium for holding longer-term securities (due to their greater risk and lower liquidity compared to short-term securities). Therefore, even if expected future short-term rates are equal to current short-term rates, the liquidity premium will make long-term rates higher than current short-term rates.

If Expected Future Short-Term Interest Rates Are Equal to Current