6. Liquidity premium theory

Which of the following is consistent with the liquidity premium theory of the yield curve?Check all that apply.

If liquidity influences the yield curve, an upward-sloping yield curve suggests that the market thinks interest rates in the future will increase.

If liquidity influences the yield curve, a flat yield curve suggests that the market thinks interest rates in the future will decrease.

If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate.

If liquidity influences the yield curve, an upward-sloping yield curve suggests that the market thinks interest rates in the future will decrease.

Caroline would like to invest a certain amount of money for two years and considers investing in a one-year bond that pays 5 percent and a two-year bond that pays 8 percent. Caroline is considering the following investment strategies:

Strategy A:Buy a one-year bond that pays 5 percent and in year one, then buy another one-year bond that pays theforward ratein year two.

Strategy B:Buy a two-year bond that pays 8 percent in year one and 8 percent year two.

If the one-year bond purchased in year two pays 9 percent, and the liquidity premium on a two-year bond is 0.7 percent, Caroline will choose .

Which of the following describes conditions under which Caroline would be indifferent between Strategy A and Strategy B?

The rate on the one-year bond purchased in year two is 10.419 percent.

The rate on the one-year bond purchased in year two is 10.732 percent.

The rate on the one-year bond purchased in year two is 11.148 percent.

The rate on the one-year bond purchased in year two is 9.898 percent.