Liquidity: Explanation and Examples
The term liquidity is used in various ways, all relating to availability of, access to, or convertibility into cash.
- An institution is said to have liquidity if it can easily meet its needs for cash either because it has cash on hand or can otherwise raise or borrow cash.
- A market is said to be liquid if the instruments it trades can easily be bought or sold in quantity with little impact on market prices.
- An asset is said to be liquid if the market for that asset is liquid
The common theme in all three contexts is cash. A corporation is liquid if it has ready access to cash. A market is liquid if participants can easily convert positions into cash. An asset is liquid if it can easily be converted to cash.
The liquidity of an institution depends on:
- the institution's short-term need for cash;
- cash on hand;
- available lines of credit;
- the liquidity of the institution's assets;
- the institution's reputation in the marketplace -- how willing will counter parties be to transact trades with or lend to the institution?