Final answer:
The liquidity premium compensates bondholders for the risk associated with the marketability of a bond. It's a part of the bond's interest rate that accounts for the potential difficulty in selling the bond quickly and at full value.
Step-by-step explanation:
The component of a bond's interest rate that provides compensation to a bondholder when a bond is not readily marketable at its full value is the liquidity premium. This is because liquidity refers to how quickly and easily an asset can be sold at a price close to its market value. A bond that is not readily marketable, or liquid, is less attractive to investors, since they may struggle to sell it if they need to convert it to cash quickly. Therefore, to compensate for this risk, a liquidity premium is added to the bond's yield.
Bonds offer varied rates of return based on the riskiness of the borrower. The interest rate on bonds includes three components: compensation for delaying consumption, inflation adjustment (inflation premium), and a risk premium. A liquidity premium is essentially a type of risk premium specifically associated with the marketability of the bond.