What does Liquidity Preference Theory focus on?

Liquidity Preference Theory is primarily concerned with the demand for liquidity, or the desire to hold cash rather than investing it in long-term securities. It emphasizes that investors prefer to have cash on hand for transactions or unforeseen expenses, which creates a demand for liquidity. This theory posits that interest rates are determined by the supply and demand for money, particularly the preference for liquidity in the face of varying time horizons.

The focus on estimating forward rates based on liquidity premiums is directly related to how the demand for cash influences the yield curve. In this context, investors demand compensation for the risk associated with the increased time commitment of holding securities instead of cash. Thus, the presence of a liquidity premium in interest rates reflects the premium that investors require for giving up liquidity.

Understanding this theory aids in grasping how interest rates can vary based on market perceptions of liquidity and cash demands, which speaks to the broader implications within money and debt markets. In contrast, the other choices do not directly address the core aspects of Liquidity Preference Theory.