Liquidity Premium


DEFINITION of 'Liquidity Premium'

A premium that investors will demand when any given security can not be easily converted into cash, and converted at the fair market value. When the liquidity premium is high, then the asset is said to be illiquid, which will cause prices to fall, and interest rates to rise.

BREAKING DOWN 'Liquidity Premium'

For example, assume an investor is looking at purchasing one of two corporate bonds , each with the same coupon payments, and time to maturity. Assuming one of these bonds is traded on a public exchange, while the other is not, the investor will not be willing to pay as much for the non-public bond. The difference in prices, and yields, the investor is willing to pay for each bond is called the liquidity premium.

  1. Liquidity

    The degree to which an asset or security can be quickly bought ...
  2. Bond

    A debt investment in which an investor loans money to an entity ...
  3. Yield

    The income return on an investment. This refers to the interest ...
  4. Premium

    1. The total cost of an option. 2. The difference between the ...
  5. Illiquid

    The state of a security or other asset that cannot easily be ...
  6. Liquid Asset

    An asset that can be converted into cash quickly and with minimal ...
Related Articles
  1. Forex Education

    Playing The Gap

    Learn how you can earn money by analyzing the disruptions in normal price patterns.
  2. Markets

    Liquidity Measurement Ratios

    Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle.
  3. Investing Basics

    What Does In Specie Mean?

    In specie describes the distribution of an asset in its physical form instead of cash.
  4. Economics

    Calculating Cross Elasticity of Demand

    Cross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
  5. Fundamental Analysis

    Emerging Markets: Analyzing Colombia's GDP

    With a backdrop of armed rebels and drug cartels, the journey for the Colombian economy has been anything but easy.
  6. Mutual Funds & ETFs

    Top 4 Investment Grade Corporate Bonds ETFs

    Discover detailed analysis and information about some of the top exchange-traded funds (ETFs) that offer exposure to the investment-grade corporate bond market.
  7. Investing Basics

    The 4 Biggest Bond Myths

    Bonds can be a great addition to a portfolio but be aware of these four myths.
  8. Fundamental Analysis

    Emerging Markets: Analyzing Chile's GDP

    Chile has become one of the great economic success stories of Latin America.
  9. Investing

    Watch Your Duration When Rates Rise

    While recent market volatility is leading investors to look for the nearest exit, here are some suggestions for bond exposure in attractive sectors.
  10. Economics

    Explaining Capital Flows

    The movement of money for investing, trade or business production, is commonly referred to as capital flows.
  1. How do I measure option liquidity?

    An option is a financial instrument that gives the holder the right to purchase shares in a company at a certain set price ... Read Full Answer >>
  2. Are high yield bonds a good investment?

    Bonds are rated according to their risk of default by independent credit rating agencies such as Moody's, Standard & ... Read Full Answer >>
  3. What are the maximum Social Security disability benefits?

    The maximum Social Security disability benefit amount for a single eligible person in 2015 is $1,165 per month, but you can ... Read Full Answer >>
  4. What is the relationship between the current yield and risk?

    The general relationship between current yield and risk is that they increase in correlation to one another. A higher current ... Read Full Answer >>
  5. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  6. What is a 'busted' convertible bond?

    In finance, a convertible bond represents a hybrid security that offers debt and equity features and risks. While a convertible ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!