Question 3 (13 marks) [Note: Keep your answer as concise as possible.]

a) How does the Liquidity Premium Theory of the term structure of interest rates differ from the pure expectations theory? (8 marks)

b) Use the Liquidity Premium Theory to explain the following statement: Although expecting increases in future interest rates could result in an upward-sloping yield curve, an upward-sloping yield curve does not necessarily imply the expectation of higher future interest rates. (5 marks)