What is Market Liquidity?
Market liquidity refers to how easily a security, or investment, can be sold and converted to cash without having much impact on the value or price. If a security is liquid, it means an investor can have immediate access to money since the investment can be sold quickly at a fair market price. The level of market liquidity can be influenced by the amount of trading activity associated with the security, as well as other factors like bond rating, maturity date, and the existence of a sinking fund. Foreign investments have varying degrees of liquidity because of laws that govern the redemption of shares from other countries. Market liquidity is also related to liquidity risk, which involves the possibility that a security cannot be easily sold.
There are several aspects that can affect the market liquidity of a security, especially for bonds. The rating and quality of the investment can influence liquidity because some investors will only buy highly rated securities. Those with a short amount of time until the maturity are more liquid than long-term securities. The coupon rate, current market value, issuer, and any call features can determine how attractive a security is to buyers, which in turn affects the liquidity. If the issuer has established a sinking fund, it typically makes the bonds more liquid because it allows the trustee to set aside cash to redeem the bonds, call them, or buy them back on the open market.
Foreign investments also have factors that have a bearing on market liquidity. The hours during which a foreign market is open for trading can vary and might be different from the market hours in an investor’s country of residence. The size of foreign markets can also play a role in liquidity. Additionally, some countries limit the foreign countries from which investments can be purchased. There might also be laws that restrict bringing money back into the home country from a foreign investment sale.
Certain types of investments are typically considered to have high market liquidity, while others are generally regarded as illiquid. For example, money market instruments are usually liquid since they have one year or less until maturity. Many bonds and United States Treasury Securities are liquid because they usually have numerous buyers and sellers at any given time. On the other hand, real estate and bank certificates of deposit are illiquid because they cannot be sold quickly or easily converted to cash.
Investors concerned with market liquidity should also be aware of liquidity risk. This type of risk is the chance that a security will sell infrequently or not at all. In some cases, a security might only be able to sell at a great discount or at a loss of principal. Liquidity risk can also refer to an issuer being unable to pay the full amount of debt obligation on the maturity date.
I guess loss of market liquidity is one of the major problems that investors face. If an investor's asset suddenly becomes illiquid, they only have two choices-- to sell to whomever is willing to buy for a lower price than they had paid to buy the asset. Or wait to see if thing improve. If an investor is in a fix and needs cash right away, I guess he would have to sell. And from what I understand, when a market loses liquidity, it can take a long time for things to improve. Liquidity management is tough.
@ddljohn-- An asset is said to have liquidity if it can be sold quickly without losing value. A market is said to have liquidity if the market has the ability to facilitate this process. It could also refer to a market with many assets that have liquidity.
Basically, what this means is that if the market is liquid, investors can sell their assets easily and without having to reduce prices. If a market is illiquid, investors will not only have trouble selling their assets, but they will also have to reduce prices considerably to sell them. So market liquidity and trading activity have a lot to do with one another.
I'm a little confused about asset liquidity vs market liquidity. An asset has liquidity but how does a market have it? I thought that liquidity was a concept that only applied to assets. Can anyone explain?
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