What is liquidity?
Liquidity is the measure of how easily it is to turn an asset into cash.
Cash and stocks usually have high liquidity as they are easy to access and trade whereas real estate is less liquid as it can take long to sell or trade.
Liquidity can refer to two different areas. Liquid asset or liquid market.
Liquid market means there are always investors on the market willing to trade assets at all price levels.
Liquid asset is an asset that can be easily turned to cash.
Why is liquidity important?
In your personal financial life liquidity is important as you can take care of financial emergencies without much cost to you.
In the financial markets liquidity is very important as it ensures you can easily get in and out of the financial markets when you sense an opportunity or crisis.
Features of liquidity
For something to be liquid it should be able to convert into cash, quickly, easily and at no cost( even opportunity cost).
This means it should not cost the seller any loss in value due to a quick sale but rather should be able to sell at market value instantly.
Example of Liquid assets
Example of non liquid assets
What is stock liquidity?
Liquidity is broken into two bits.
Stock liquidity and accounting liquidity
Stock liquidity has to do with the speed at which a transaction is completed from the time it is put up by the seller to the time it is bought by the buyer.
This determines how liquid it is.
What is accounting liquidity?
Accounting liquidity has to do with the measure of someone's current liquidity. So how quickly you would have access to money if you needed it. You can measure this through the current ratio, cash ratio or acid test formulas.