Question #74
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 29
Status: Unattempted
Question
What are the implications for the shape of the yield curve according to the liquidity theory? The yield curve:
Answer Choices:
A. may have any shape
B. is always flat
C. must be upward sloping
Explanation
The liquidity theory holds that investors demand a premium to compensate them to
interest rate exposure and the premium increases with maturity. Even after adding the
premium to a steep downward sloping yield curve the result will still be downward sloping.