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What is Liquidity?
Liquidity is the ease and speed with which an asset or security can be bought or sold.
What Does Liquidity Mean in Finance?
Financial liquidity refers to how easily assets can be converted to ready cash without affecting its market price. Assets like stocks and bonds are very liquid and can be converted into cash within days. Larger assets and tangible items such as property and equipment are often not as liquid since they need to be sold before you can use and spend the cash that they are worth, which can take weeks or months. Cash (including checking accounts) is considered the most liquid asset. Investments such as stocks and bonds are liquid assets that are easily converted to cash. Assets that take longer to convert to cash include preferred or restricted stocks since they have covenants that dictate how and when they can be sold.
Liquidity in the Market
Market liquidity refers to the market’s ability to allow assets to be bought and sold easily and quickly. The stock market for example is a highly liquid market.
The liquidity of a stock can be determined by the difference between its ask and bid prices. The bigger the difference between the ask and bid price of a stock, the less liquid that stock becomes.
Why is Liquidity Important?
It is important for companies and individuals to know the liquidity of their assets to know how easily short-term liabilities can be paid off.
Liquid assets give you more flexibility. Quick access to cash gives you the ability to pay bills and debts if your stream of cash or income is disrupted. Liquid assets are important to have in an emergency fund so that money can be accessed when needed.
Learn more about financial skills for investors who are just starting out.
