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What Is Liquidity?

Liquidity is a market term used to describe how easily an entity can quickly change a commodity or assets to physical cash without disrupting the market price at a particular time. An investment can be said to have high liquidity or low liquidity.

An asset is said to have high liquidity if it can easily be converted to cash at a market price without stress and delay. While an asset is said to have low liquidity if it is not easily converted to physical cash

Deeper Definition

To understand liquidity, liquidity is all about how easily an asset can be bought or sold at a specific market price that reflects its real-time and intrinsic value. In the apparent sense, cash or physical money is what suits this definition the most. It is a ledger tender within a domain or country that can be used to purchase anything. Stocks and Shares are also liquid.

There are about three main types of liquidity.

  • Accounting liquidity
  • Asset liquidity
  • Market liquidity

Accounting Liquidity

This type of liquidity describes how a company can quickly settle any of its financial commitments such as securities, inventories, receivables, and the likes. This generally reflects the health and the worth of a company, and this can be ascertained by checking the performance of the stock of the company.

Asset Liquidity

This describes how an asset can be traded and converted to cash at a particular time. There is usually no alteration in cash value, so cash is the perfect liquid asset. Apart from cash, there are other examples, Stocks, Bonds, and Cryptocurrencies. All of these assets are liquid, but their value fluctuates remarkably when compared to cash.

Market liquidity

This type of liquidity is described as more of a condition than a value. It is described as a market condition reflecting the market forces of demand and supply (buying and selling). The market is all about buying and selling, but some market conditions tilt towards buying, and some tilt predominant towards selling. For example, during Stock or Fx bullish runs, more buyers are engaged than sellers. While during bearish runs, more sellers are engaged

Liquidity Example

A vehicle as an asset can have its liquidity assessed by the ease at which it can be sold off to generate cash. So, quick sale equals high liquidity for the vehicle.

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