Long-term investments may come with a term premium, a rate of return that incentivizes investors to invest in illiquid assets. Short-term investments are more attractive to investors, who demand a term premium for long-term investments. Liquidity premiums are offered for illiquid assets. Long-term investments tend to be less risky.
A term premium is a rate of return on an asset that provides an incentive to invest in that asset even though it is a long-term investment that may also be illiquid in nature. In a situation where an investor is evaluating two similar assets but one matures later than the other, the one that will take longer to mature may be accompanied by a term premium. If it is not, the investor will be more inclined to take the investment in the short term because it will generate a profit more quickly and the investor’s money will not be locked up for an extended period.
In a graph of a yield curve showing the types of returns provided by different types of investments, it can be seen that long-term investments tend to yield more. This is the result of the prime term; These investments must yield more, or investors will not find them attractive. Shifts in the yield curve appear in response to economic pressures such as a recession, slow movement in the investment field, and other factors.
From the point of view of an investor presented with two identical investments of different duration, the short-term investment will be more attractive. It allows the investor to earn money and then move on, freeing up capital for other businesses. Therefore, investors demand a term premium for long-term investments to provide them with a reason to invest in such bonds and other securities.
This concept is also related to a liquidity premium. The more liquid an investment is, the easier it is to transfer or sell it. Liquid assets attract investors more. When an asset is illiquid, investors can expect to be offered a liquidity premium as a form of compensation. The company offering the investment offers a premium designed to attract investors without compromising the investment instrument.
Investors are more likely to take risks in short-term investments because they believe they can make more accurate predictions about the direction of the market when forecasting in the short term. As a result, in addition to coming with a higher rate of return in the form of a term premium, long-term investments also tend toward the less risky side. Investors are less inclined to risk a risk that they will have to worry about for 15 to 20 years than a risk that will worry them for six to 18 months.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
