The liquidity premium theory of the term structure assumes:
A) that interest rates on long-term bonds respond to supply and demand conditions for those bonds.
B) investors have a preference for short-term bonds, as they have lower interest-rate risk.
C) that an average of expected short-term rates is an important component of interest rates on long-term bonds.
D) all of the given answers are correct.

Question

Quizplus · Accepted Answer

The liquidity premium theory incorporates all the given statements: it suggests that long-term interest rates reflect expected future short-term rates, adjusted for a liquidity premium due to the greater risk of holding long-term bonds, and that these rates are also influenced by supply and demand conditions specific to long-term bonds.

The Liquidity Premium Theory of the Term Structure Assumes