- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 26. The Term Structure and Interest Rate Dynamics
- Subject 4. Traditional Theories of the Term Structure of Interest Rates
CFA Practice Question
The liquidity theory explains why the yield curve is:
B. always upward-sloping.
C. flat or downward-sloping most of the time.
A. upward-sloping most of the time.
B. always upward-sloping.
C. flat or downward-sloping most of the time.
Correct Answer: A
The theory assumes that investors always charge a premium for tying up their capital for a longer period. Therefore, forward rates will embody a liquidity premium. Even if future interest rates are expected to be unchanged or fall, with a liquidity premium increasing fast enough with maturity the yield curve is most likely to be upward-sloping.
User Contributed Comments 6
| User | Comment |
|---|---|
| mysking | what's the different between A & B? always = most of the tme |
| bmeisner | Mysking doesn't read good. |
| noonah | If future interest rates fall and the long-maturity premiums do not rise enough to compensate, then the curve will not be upward sloping, and hence the "most of the time" |
| AusPhD | bmeisner, you made me laugh out loud, classic! |
| tabulator | cruel, CRUEL bmeisner! |
| bodduna | "most of the time" != "always" |