According to the liquidity premium theory of the term structure,when the yield curve has its usual slope,the market expects
A) short-term interest rates to rise sharply.
B) short-term interest rates to drop sharply.
C) short-term interest rates to stay near their current levels.
D) none of the above.

Question

Quizplus · Accepted Answer

The liquidity premium theory states that long-term interest rates consist of a combination of expected future short-term rates and a liquidity premium to compensate for the greater risk of holding longer-term bonds. Therefore, when the yield curve has its usual slope, it implies that the market expects short-term interest rates to remain near their current levels.

According to the Liquidity Premium Theory of the Term Structure,when