The term 'Liquidity' is included in the Investments edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Liquidity refers to the point that a security or asset is able to be sold or bought in a given marketplace without interfering with the price of the asset. Good liquidity is demonstrated through a great amount of trading activity. Liquid assets prove to be the kinds that are simply and quickly able to be purchased and sold. Liquidity can be summed up in a single sentence as the capability of rapidly turning an asset into cash.
Although no single means of determining liquidity exists, liquidity can be figured up through utilizing liquidity ratios. It is generally accepted that investing money in liquid assets proves to be safer and more accessible than placing your money into illiquid ones. The reason for this is that you are able to withdraw your money from a liquid investment quickly and without obstacles.
There are many types of assets that prove to be simply convertible into cash. Money Market accounts are some of the most liquid assets. Blue chip stocks turn out to be the most liquid of stocks traded.
Liquidity also has other meanings for businesses and economics. A business’ capability of fulfilling its payment responsibilities is referred to as its liquidity. This is figured both with regards to the company having enough liquid assets that they are able to get to in a timely fashion.
The most liquid asset is money in your hand. This can be utilized right away for all economic functions. Among these are selling, buying, taking care of immediate needs and desires, and paying down debts.
In general, liquid assets possess many or at least a few of a number of features in common. These assets that have good liquidity are able to be sold at any point during market operating hours, quickly, and with as small a loss in value as possible. Markets with liquidity possess numerous sellers and buying who are both willing and able to transact at all times that the market is open. For markets to have deep liquidity, eager and willing parties in great numbers have to be present in a market all of the time that it is open.
The liquidity of a market has much to do with its market depth. Market depth is able to be quantified as the number of individual units that may be purchased or sold for a certain price impact. The opposite of this related term market depth is market breadth. Market breadth is quantified as the amount of price impact for every unit of such liquidity.
A given item’s liquidity is measurable in terms of how frequently it is sold or purchased. This is called volume. Investments in markets with great volume like futures markets and the stock markets are generally understood to have far greater liquidity than do real estate markets. This is simply a function of stocks and futures’ capability of being rapidly transacted.
There are assets that possess even liquid secondary markets. These offer greater advantages for traders, and because of this, buyers will pay a greater price for such an asset than for an asset that is similar but does not possess a liquid secondary market. This liquidity discount proves to be the lowered anticipated return or guaranteed yield on these kinds of assets.
An example of this is the variance between just issued U.S. Treasury bonds and treasuries that are no longer recently issued. Both may have the same amount of time until they mature, but investors are more interested in purchased the ones that have only just been issued. Because of this, these newest ones have a higher price and lower yield.