Explain liquidity premium theory

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Suppose that the one-year interest rates over the next five years are expected to be 5%, 6%, 7%, 8% and 9%, while investors preferences for holding short-term bonds means that liquidity premiums for one-to five-year bonds are 0%, 0.25%, 0.5%, 0.75% and 1% respectively. What would be the interest rate on the two-year and five year bond under the Liquidity Premium theory?

Reference no: EM132909264

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