liquidity

The ease with which an asset can be converted into cash without significantly affecting its price.

Types

1. Market Liquidity:
   • how easily an asset can be traded in the market without impacting its price
   • high liquidity ⇒ there are many buyers and sellers
   • Stocks that are traded very frequently have high liquidity
2. Asset Liquidity:
   • how easily a specific asset can be convert into cash
3. Liquidity of Companies:
   • how easily it can meet its short term obligations using its assets
   • enough liquidity ⇒ enough cash or easily-convertible assets to cover due bills
4. Liquidity in Banking:
   • banks need to maintain liquidity to meet the demand from the depositors and other short-term obligations

Factors

• something that is more in Market Demand i.e., more people want to buy or sell an asset. Then the asset tends to be more liquid
• frequently traded assets ⇒ constant flow of transactions ⇒ more liquidity
• the asset type (stock and govt. bonds $>$ real estate or private equity)

Importance

Higher liquidity implies that

• investors can exit positions quickly without large price changes
• markets can avoid extreme price fluctuations¹
• companies can meet financial obligations and avoid insolvency

Examples of Liquidity

• A Savings account can be converted to cash instantly ⇒ highly liquid asset
• A house may take months to sell and might require lowering for price ⇒ less liquid

Footnotes

1. How?doubt ↩