What is liquidity?
Liquidity can describe how readily an asset can be sold without a large price concession or how an institution meets payments as they fall due. Market and funding liquidity are related but distinct.
Types of liquidity
1. Asset liquidity Cash is highly liquid. An actively traded asset may also be easy to sell, but price impact and transaction costs matter. The ability to sell is not a guarantee of a particular price. 2. Funding liquidity A profitable business can still lack cash when bills fall due. Timing of inflows and payments matters. Banks also need liquidity to meet short-term obligations and settle payments. 3. Depth and bid-ask spread Orders at multiple price levels help absorb trades. The bid-ask spread is a transaction cost. A displayed last price does not mean a large position can be sold at that price. 4. Stress conditions Markets that appear liquid in normal times can lose buyers in a crisis. Redemption terms, funding structures and cash buffers matter. Diversification cannot eliminate liquidity risk.
Risks and examples
5. Deposits versus investments Access to a demand deposit differs from a fund redemption or selling property. Review settlement times, contractual conditions and possible charges. Emergency funds need suitable accessibility. 6. Questions to ask When is cash needed? How many buyers are available? What are the spread and exit terms? How much might the price move in a stressed sale? These questions reveal more than turnover alone.