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What are the implications for the shape of the yield curve according to the liquidity theory? The yield curve:

A)
must be upward sloping.
B)
is always flat.
C)
may have any shape.



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.

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The liquidity premium theory of the term structure of interest rates projects that the normal shape of the yield curve will be:

A)
variable.
B)
downward sloping.
C)
upward sloping.



The liquidity theory holds that investors demand a premium to compensate them to interest rate exposure and the premium increases with maturity. By itself, the liquidity theory implies an upward sloping yield curve.

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