Based on the liquidity preference theory, the shape of the yield curve should be: A) downward sloping. B) flat. C) flat, upward or downward sloping. D) upward sloping. Answer is D But it seems like a really bad question, because any shaped curve can still apply to the liquidity preference theory correct? Doesn’t it just mean that a downward sloping curve would be “less” downward sloping due to a preference for liquidity??
Yes, but in the “normal” scenario the shape should be upward sloping to account for the additional risk
well said my friend
Yes any shaped curve can still apply to liquidity preference theory. But under “normal circumstances,” where rates will remain stable or increase, the curve should be upward-sloping. But yeah, this question isn’t specific enough.
The thing they are driving at is that the liquidity prefence always creates an upward sloping yield curve… but other factors could have a more dominant effect and create a downward or humped shaped curve.
Unless are specified “particular” market condition in the question, always consider upward trend