The liquidity premium theory of the term structure
A) assumes investors tend to prefer short-term bonds because they have less interest-rate risk.
B) assumes that interest rates on the long-term bond respond to demand and supply conditions for that bond.
C) assumes that an average of expected short-term rates is an important component of interest rates on long-term bonds.
D) assumes all of the above.
E) assumes none of the above.

Question

Quizplus · Accepted Answer

The liquidity premium theory assumes all of the above - that investors prefer short-term bonds due to lower interest-rate risk, that long-term bond interest rates respond to demand and supply conditions, and that an average of expected short-term rates is an important component of long-term bond rates.

The Liquidity Premium Theory of the Term Structure