The theory which adopts the view that the term structure reflects the future path of interest rates as well as a risk premium is the:
A) The liquidity theory.
B) The pure expectations theory.
C) The preferred habitat theory.
D) The market segmentation theory.
E) None of the above.

Question

Quizplus · Accepted Answer

The preferred habitat theory suggests that the term structure of interest rates is determined by both investors' expectations of future interest rates and a risk premium that investors require for holding longer-term bonds, which are considered riskier than shorter-term bonds. This theory combines elements of the expectations theory, which focuses solely on future interest rates, and the liquidity premium theory, which adds a risk premium to longer maturities.

The Theory Which Adopts the View That the Term Structure