Liquidity Spread

Liquidity spread is the difference between the locked-in yields of bonds and short-term interest rates. The "normal" state of affairs is that as the time to bond maturity lengthens, the greater the return rate and this is illustrated by a yield curve that slopes upwards as bond maturities lengthen.

This relationship deals directly with the added risk that investors assume with a longer time to maturity, as this increases the possibility that short-term interest rates could narrow the difference in the spread between the bond and the prevailing interest rate. The Arbitrage Pricing Theory states that the longer the term to maturity, the higher the yield. This rewards investors willing to lock their money into long-term bonds despite the increased risks.