- CFA Exams
- CFA Level I Exam
- Topic 6. Fixed Income
- Learning Module 28. The Term Structure and Interest Rate Dynamics
- Subject 4. Traditional Theories of the Term Structure of Interest Rates
CFA Practice Question
The liquidity preference hypothesis states that the forward rates are set higher than the expected spot rates because:
A. Of a downward sloping yield curve.
B. Long-term rates are higher than short-term rates.
C. Investors must be induced to buy the riskier long-term bonds.
Explanation: Long-term bonds should always provide a maturity premium to compensate for the liquidity risk.
User Contributed Comments 6
| User | Comment |
|---|---|
| danlan | Why not B? |
| gsuwp | B does not give the reason why... |
| mordja | B is merely a restatement of the question, it is not a reason. C explains why Forward rates must be higher than short term rates....under this hypothesis anyway. |
| olagbami | dont 4get dat anoda name for the liquidity preference theory is maturity premium theory. Hence longer-term bonds attract higher yields than short-term bonds. |
| group | That's why there is a liqudity risk premium built up in the forward rate to provide a balance between risk and reward |
| vi2009 | Longer holding period, riskier as there is the uncertainty elements wrt interest rates. |