Using the yield curve expectation theory, assume that all participants in the bond market (lenders and borrowers) expect the interest rate to rise. Use this assumption for both parts of this question.

Starting with a flat yield curve, explain how the expectation by lenders (savers) and borrowers that interest rates will increase will change the shape of the yield curve.

Be specific by first discussing the behavior of the savers (lenders) side of the bond (Treasury security) market and then the behavior of the borrower side of the market. Be sure to indicate what happens to our flat yield curve based on the behavior of each side of this market.

A. What (explain) is a liquidity premium for the term structure of interest rates? This is a definition not a number!

B. Given the change in the shape of the yield curve which you made in part 1 of this question, what happens to the shape of this yield curve by adding a Liquidity Premium. Explain your answer