interest rate question question

spartan1

Under the liquidity theory, if the yield curve is flat, the short term interest rate:

a. increase
b. decrease
c. remain unchanged

dmar

I went with B too

Wasteoftime

Agreed, i actually remember this question with detail because i wrote a message next to it in the booklet to the institute saying "the answer is appropriately b but it's a crap question because if the liquidity preference is given an arbitrary value of zero it could be flat or decrease".

koba

i dont get it...why would it decrease??

If investors require a liquidy premium on top of pure expectations theory...shouldnt the yeild curve be upward sloping??


markCFAIL Wrote:
-------------------------------------------------------
> Agreed, i actually remember this question with
> detail because i wrote a message next to it in the
> booklet to the institute saying "the answer is
> appropriately b but it's a crap question because
> if the liquidity preference is given an arbitrary
> value of zero it could be flat or decrease".

leadcfa

i too put B , if yield curve remains flat , then short term interest rates has to go down to compensate for above yield interest rates in long term (due to less liquidity) .

i don't know if it's actually true or not , nothing else made any sense because it's written in CFAI that yield is complex average of spot rates , ... i'm f***ing confused :O.

ogoluwa

According to Mr. Schweser,

""An upward sloping yield curve can be consistent with the liquidity preference theory even with expectations of declining short term interest rates.""

Which apparently negates what all you people are mentioning or am i missing something ?

joemoran

Yea this is confusing I likely got it wrong, I put that they would increase because I knew it was naturally an upward sloping line meaning long term rates are higher so to make it "flat" you would have to raise the short term end of the yield curve. I have no idea.

rgonzalez

i think i went with decrease too..

btcapital

Upward sloping could be liquidity preference like now. If there was a huge demand for short term instruments for safety reasons but rates were expected to come down in the future you could still have an upward sloping curve.

As many investors have a preference to their given spot because of the rate that is given, the LPT states that the curve should be upward sloping as people need to be compensated for the excess time.

The current answer is decrease as with a flat curve implies that rates are coming down but demand is not enough to outpace the supply in the short term.

kd26gioi

Damn, add another one to the list I got wrong. It is decrease according to the book.