If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure? Would you be more or less willing to accept the pure expectations theory?

 A. The one-year interest rate over the next 10 years will be 3%, 4.5%, 6%, 7.5%, 9%, 10.5%, 13%, 14.5%, 16%, 17.5%. Using the pure expectations theory, what will be the interest rates on a 3-year bond?  

 

B. Using the information from the previous question, now assume that the investor prefers holding short-term bonds. A liquidity premium of 10 basis points is required for each year of a bond's maturity. What will be the interest rates on a 9-year bond? 

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Answer Yield Curve Liquidity Premium and Pure Expectations Theory A flat yield curve where interest ... View the full answer