Liquidity Premium Calculator

Formula

The formula to calculate the Liquidity Premium (LP) is:

\[ LP = AR - \left(RFR + \left(MR - RFR\right)\right) \]

Where:

\( LP \) is the Liquidity Premium (%)
\( AR \) is the Asset Return (%)
\( RFR \) is the Risk-Free Rate (%)
\( MR \) is the Market Return (%)

What is a Liquidity Premium?

A liquidity premium is the additional return that investors demand for holding an asset that is not easily converted to cash without a significant loss in value. Assets that are less liquid, like real estate or certain bonds, tend to have a higher liquidity premium compared to more liquid assets like stocks or government bonds.

Example Calculation

Let's assume the following values:

Asset Return (AR) = 8%
Risk-Free Rate (RFR) = 2%
Market Return (MR) = 6%

Using the formula to calculate Liquidity Premium:

\[ LP = 8 - \left(2 + (6 - 2)\right) = 8 - 6 = 2\% \]

The Liquidity Premium is 2%.