 in this section we are going to discuss the liquidity premium theory so liquidity premium theory is saying that when we decide to make a short term investment or long term investment so we consider the yields that we expect from the short term investment and the long term investments and in doing that what we do is we always compare that the yield from the long term investment it should be equivalent to the average of the short term bonds or short term investment we compare the yields with the average of the long term investment so the two things are taken into account plus there is another third thing which is specifically highlighted by the liquidity premium theory which says that when you are intending to invest in a long term bond so you are comparing the yields with the average of the short term investment opportunities but along with that you demand a liquidity premium because we are going to withhold our cash for a certain long time period for example if we decide to invest in a 20 year maturity bond which is going to be mature after 20 years or 30 years so we cannot use our cash for 30 years so what I am going to do is explain the liquidity premium theory that what the investor does is he considers three things the first thing is he considers that when I am investing for 30 years 30 years after 30 years in a bond so how much yield will I get over this and the short term bonds that I will take in these 30 years the yield will be compared to the yield of this long term bond and the third thing which is considered by the liquidity premium theory according to the feature the third thing which is considered by the investors and that is the liquidity premium it means that they are going to be separated from their cash for 30 years so for that they demand an extra higher interest rate or expect that we will get compensation for that 30 years to be separated from our cash so together when we look at the yields that are there for the long term investments we say according to the liquidity premium theory that there are these three things that are considered by the investors so whenever the planners of the different types of bonds decide or financial analysts compare the yields that we should invest in so they consider these three aspects so we have a key assumption for this particular theory and that says that we can take the long term investment opportunities and the short term investment opportunities as the substitutes of each other so we discussed that the rational expectation theory was that the different types of bonds that are short term or long term are the perfect substitutes then we discussed the segmented market theory in which we said that no one has to take it they cannot be considered as substitutes because the long term long term investment is a completely different market and the short term investment the investor considers the different factors and constitutes a different market whereas when we look at the liquidity premium theory it takes into account the short term bonds and the long term bonds markets as substitutes although they say that they are not perfect substitutes because there is this liquidity premium also a third factor they have introduced which is considered an investor when they have to decide between investing in the short term investment opportunities or the long term investment opportunities so we can say that the two things can be considered the different, the bonds with different maturities can be considered as the substitutes of each other but they cannot be considered as the perfect substitutes that they cannot replace each other there are certain features that are considered by the investor that they consider the liquidity premium if the liquidity premium is the desired rate which is made in the market, expected matches with that only then they will be investing in the long term bonds otherwise they will prefer to invest in the short term bonds so when they have to make the investment decisions these are the three important factors that are considered by the investors so the theory is that there can be a market there can be a same market in which bonds with different maturities sell, demand, buyer selling they are not distinct markets and then we also see that according to the liquidity premium theory bonds of different maturities can be considered as an alternative option but they cannot be considered as the perfect substitutes and thirdly, another important factor which the theory tells us is that the investor because he is the worst therefore he prefers short term bonds over long term bonds so if the company that is selling or the government that is selling long term bonds then they have to consider terms and conditions defined that how much you will get the yield how much you will get the rate of return so they will have to consider this aspect also when investors have to decide whether to invest in the short term investment opportunity or the long term investment opportunity they will not only consider the yield which you are offering rather they are going to consider that you are going to give them something at the top of it something at the top of the average of the short term bonds which is considered as a liquidity premium whose basis customer or investor will decide that you have to invest your money for the long term so you have to account for a liquidity premium when you are going to decide this is going to be the return which we are going to offer you if you invest with us for like 20 years or 35 years or 40 years or for a longer time period so this is how we can explain this concept of liquidity premium theory