When it comes to financial terms, you will almost always hear of the word “liquidity.” For instance, they say that the forex market sports the highest level of liquidity among the financial markets. That’s definitely true, by the way.
But what do we really mean when we say liquidity? And which assets are considered highly liquid.
In this article, we’re going to discuss what liquidity means for the financial markets. We will also give you some ideas about the assets that are considered to have adequate amount of liquidity.
What is liquidity?
The term liquidity refers to the ease at which the assets can be converted into cash. For instance, stocks and bonds are considered to be highly liquid since they can be easily converted into cold cash in a matter of days.
On the other hand, large assets like properties, plants, and equipment cannot be easily turned into cash. It would usually take at least a week or so before you can lay your hands down on the cash.
Liquidity in the Financial Industry
In finance, cash is considered to be the most liquid asset, well, for obvious reasons. Meanwhile, as mentioned, assets like stocks and bonds are also considered to be highly liquid since you can quickly exchange them for cash if you want to.
On the other hand, there are also some exemptions that prove that rule. Some investment assets can take a longer time before you can finally convert them into cold cash. For instance, there are preferred or restricted shares. These are shares that have covenants that wield the power to tell how and when the shares can be sold and therefore be converted into cash.
Items like coins, stamps, and other collectibles are treated to be less liquid than cash. Most of the time, the investor wants to get the full value of the said items. He or she may sell to another collector at full value, but this person will probably have to wait for a longer time to find the right buyer.
Meanwhile, if he wants to liquidate the assets faster, then he will have to give the item a discount or lower the price. He will almost certainly have to ask the help of a broker to meet this end.
Land, real estate, and building are considered to be the least liquid assets in the financial industry since it usually takes at least several months before such properties are sold and converted into cash.
Market Liquidity
This refers to the ability of the market to facilitate the buying and selling of assets quickly and easily.
The market of a stock can be considered liquid if you can buy and sell shares quickly. Of course, the trade should have little to no impact on the stock’s price. The company stocks that you usually trade on the major exchanges are generally considered to be liquid.
If an exchange has high volume of trade, the bid and ask price should be close to each other. In other words, you shouldn’t have to pay more to buy the stock and you should be able to liquidate it more quickly. As the spread between the bid and ask prices become wider, the market becomes more illiquid.
