D) It is theoretically possible for the yield curve to have a downward slope,and there have been times when such a slope existed.That situation was probably caused by investors' liquidity preferences,i.e. Description of Preferred Habitat Theory The Preferred Habitat Theory could be described as a partial expectations theory. According to this theory the risk premium of a debt instrument need not be directly â¦ We often observe that longer-term yields incorporate a premium over the geometric mean, termed the liquidity premium, which is the subject of the liquidity preference theory for the most part. The normal upward-sloping yield curve follows the âLiquidity Preference Theory,â which suggests that investors wish to be compensated for holding longer-term securities. The supply of money together with the liquidity-preference curve in theory interact to determine the interest rate at which the quantity of money demanded equals the quantity of money supplied â¦ Liquidity Preference Theory â¢Definition: states that investors always prefer the higher liquidity of short-term debt and therefore any deviance from a positive yield curve will only prove to be a temporary phenomenon â¢Assumption: bonds with longer maturities have higher yields â¢Acknowledges the risks involved in holding long-term Yield Curves A Yield Curve expecting interest rates to rise â¦ The liquidity-preference relation can be represented graphically as a schedule of the money demanded at each different interest rate. The longer they prefer liquidity the preference would be for short-term investments. The relationship between yields on otherwise comparable securities with different maturities is called the term structure of interest rates. The Liquidity Preference Theory is also known as the liquidity preference hypothesis. Also learn about the possibility of zero rate of interest. In this video clip I explain the demand for money in terms of the liquidity preference theory of Keynes. Yield curve The plot of yield on bonds of the same credit quality and liquidity against maturity is called a yield curve. In mathematical terms, LPT differs in its calculation of the yield curve only with respect to an additional risk premium (rp) component added to the expected rate of the pure expectations theory. 1. Liquidity Preference Hypothesis. The most common and closely examined investment pattern by the investors is the yield curve. Answer to Yield curve?) Liquidity preference theory recommends that a financial specialist requests a higher loan cost or premium on securities with long term maturities that convey more serious hazard since, every single other factor being equivalent, investors lean toward money or other exceedingly fluid â¦ Books. Liquidity preference theory is essentially an improved version of the pure expectations theory. Liquidity Preference â¦ The liquidity preference theory states that the yield curve should almost always be upwardâsloping, reflecting bondholders' preference for the liquidity and lower risk of shorterâdated bonds. THE LIQUIDITY-PREFERENCE THEORY. Investor takeaways The cubic spline method imposes certain conditions on the curves, which makes it possible to solve the system. This means that long-term interest rates are generally higher than short-term rates most of the time. â¢ The Liquidity Preference Theory, an offshoot of the Pure Expectations Theory, asserts that long-term interest rates not only reflect investorsâ assumptions about future interest rates but also include a premium for holding long-term bonds, called the term premium or the liquidity â¦ The liquidity preference theory suggests that for any given issuer, long-term interest rates tend to be higher than short-term rates due to the lower liquidity and higher responsiveness to general interest rate movements of longer-term securities, this causes the yield curve to be upward-sloping.