Exam 6: The Risk and Term Structure of Interest Rates

The ________ of the term structure states the following: the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a term premium that responds to supply and demand conditions for that bond.

If the yield curve is flat for short maturities and then slopes downward for longer maturities,the liquidity premium theory (assuming a mild preference for shorter-term bonds)indicates that the market is predicting.