Liquidity

Introduction

• Liquidity refers to the degree to which an asset or security can be quickly bought or sold in the existing market at a price reflecting its intrinsic value. 
• In other words, it is the ease of converting any asset into cash. 
• It is also the accessibility to investment which takes into account how much time it would take to access the investment when needed. The process of such a conversion differs from asset to asset. 
• For example, in the case of a retirement fund, it will not be able to liquidate the funds without the necessary paperwork that may be time-consuming. On the other hand, a demand deposit with the bank can be accessed easily when needed. This means the demand deposit is more liquid than the retirement fund. 

Liquidity Order

• Cash is universally recognized as the most liquid asset, while tangible assets, such as real estate, fine art, etc. are all relatively less liquid.  
• Other types of financial assets, ranging from equities to partnership units, fall at various places on the liquidity spectrum. The liquidity of these kinds of measures are in order M1>M2>M3>M4 i.eM1 is most liquid and M4 is least liquid.
• Some of the liquid assets are Cash (Highly Liquid), Demand deposits, Stocks, Fixed deposits, Government Securities, etc.

Market Liquidity

• It is a measure of how many buyers and sellers are present in the market, and whether transactions can take place easily. 
• Usually, liquidity is calculated by taking the volume of trades or the volume of pending trades currently on the market.
• High levels of liquidity in the market arise when there is a significant level of trading activity and when there is both high supply and demand for an asset, as it is easier to find a buyer or seller. 
• If there are only a few market participants, trading infrequently, it is said to be an illiquid market or to have low liquidity.