A2) Assuming a mild preference for shorter-term bonds, the liquidity premium theory suggests that a flat yield curve is an indication of:

A) constant short-term interest rates in the near and further future.

B) a slight rise in short-term interest rates in the near future and a slight decline in the further future.

C) constant short-term interest rates in the near future and a slight decline in the further future.

D) a slight decline in short-term interest rates in the near and further future.

Support your answer using a numerical example and explain carefully all the assumptions you make. [13 marks]