ACCA FM · Chapter 14 · Question 10 of 10
A normal yield curve slopes upwards, showing that longer-term debt has higher yields than shorter-term debt. Which theory explains this by saying that investors require extra compensation for tying up their money for longer?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) Liquidity preference theory
Explanation
Liquidity preference theory states that investors prefer to hold liquid, short-term assets, so they demand a premium for lending long term. This produces an upward-sloping yield curve even when interest rates are not expected to change. Expectations theory explains the shape of the curve by forecast future rates, and market segmentation theory by separate supply and demand in different maturity sectors.
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