2) Which of the following yield curves cannot be possible (the one yield curve t

Question

2) Which of the following yield curves cannot be possible (the one yield curve that can never happen, under any circumstances) when the Liquidity Preference Theory is used instead of the Expectations Theory to try to explain the direction of future interest rates? a) Upward sloping. b) Downward sloping. c) Flat sloping d) Sawtooth pattern 3) When the current market rate is greater than the original coupon rate of a bond, the bond is trading at a bond, the bond is trading at a . ; When the current market rate is less than the original coupon rate of a

Explanation / Answer

2.

Liquidity preference theory states that investors require additional liquidity premium for long term investment. So, yield curve in liquidity preference theory should be upword sloping. but if other factor of yield in long term is lower then it might be downward or steeper yield curve as well.

A Sawtooth shae yield curve is not possible in liquidity preference theory.

Option (D) is corrct answer.

3.

The relationship between price of bond and market interest rate is inverse. That is when interest rate rise, price of bond decreases and when interest rate falls bond price increase. So, if current market rate is greater than coupon rate then price of bond must be lower than Par value. So, bond is trading at discount.

again id market rate is lower than coupon rate then bond price must be higher than Par value, so bond is trading at premium.

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