Final answer:
Investors would expect a higher rate of return for longer-term investments according to the liquidity preference theory, which factors in a premium for reduced liquidity. Bonds with longer maturities typically offer higher interest rates to attract investors due to the increased risk associated with delaying liquidity.
Step-by-step explanation:
According to the liquidity preference theory of the term structure of interest rates, on average, one would expect investors to require a higher rate of return for investments with longer maturities. This theory asserts that investors prefer liquid assets, meaning they value the flexibility of being able to quickly and easily convert assets into cash. Therefore, to invest in less liquid, longer-term securities, investors would typically demand a premium, known as a liquidity premium.
For bonds, this means that the longer the term of the bond, the higher the interest rate (or yield) investors will require to compensate for the bond's reduced liquidity. Additionally, an investor who buys a bond expects to receive a rate of return that compensates for delaying consumption, adjusts for expected inflation, and includes a risk premium corresponding to the borrower's riskiness.