Under the liquidity premium theory,a flat yield curve indicates that investors expect future short-term rates to
A) fall.
B) rise.
C) remain constant.
D) either fall or remain constant.

Question

Quizplus · Accepted Answer

The liquidity premium theory suggests that long-term interest rates not only reflect investors' expectations about future short-term rates but also include a premium for holding longer-term bonds, due to their greater risk. A flat yield curve under this theory indicates that investors expect future short-term rates to fall, as the premium added to long-term rates for their increased risk is offset by the expectation of lower short-term rates in the future.

Under the Liquidity Premium Theory,a Flat Yield Curve Indicates That