According to the liquidity premium theory of interest rates,
A)long-term spot rates are totally unrelated to expectations of future short-term rates.
B)the term structure must always be upward sloping.
C)investors prefer certain maturities and will not normally switch out of those maturities.
D)long-term spot rates are higher than the average of current and expected future short-term rates.
E)investors are indifferent between different maturities if the long-term spot rates are equal to the average of current and expected future short-term rates.

Question

Quizplus · Accepted Answer

The liquidity premium theory of interest rates posits that long-term spot rates are higher than the average of current and expected future short-term rates, due to the premium that investors demand for holding longer-term bonds that are less liquid than shorter-term bonds. The theory does not require a specific shape for the term structure, nor does it assume that investors are entirely indifferent between different maturities.

According to the Liquidity Premium Theory of Interest Rates