-Refer to Figures A, B, and C. According to expectations theory, which of the figures reflects expectations that the short-term interest rate is expected to remain constant in the future but that borrowers and lenders also must be compensated with a liquidity premium for lending long?
A) Figure A
B) Figure B
C) Figure C
D) Both a and b

Question

-Refer to Figures A, B, and C. According to expectations theory, which of the figures reflects expectations that the short-term interest rate is expected to remain constant in the future but that borrowers and lenders also must be compensated with a liquidity premium for lending long?
A) Figure A 
B) Figure B 
C) Figure C 
D) Both a and b

Quizplus · Accepted Answer

Figure A reflects expectations that the short-term interest rate is expected to remain constant in the future but includes an upward slope to account for the liquidity premium required by lenders for longer-term loans. This is consistent with the expectations theory, which suggests that the shape of the yield curve reflects expectations of future interest rates, with adjustments for premiums such as liquidity.