Liquidity is basically the extent upto which any security or asset could be traded in the financial market without any change in the price of the asset. Liquidity is also called marketability. If an asset is described as being liquid it means that it can be changed into cash pretty easily.
Liquidation is the process whereby an asset having lesser amount of liquidity is exchanged with an asset that has a higher degree of liquidity.
Importance of Liquidity
As per the principles of investment it is always better to put one’s money in assets that have a high level of liquidity. The main reason behind such an assumption is that the investor is more likely to make decent profits from such investments.
Liquid Assets
The assets, which have a higher degree of liquidity, are called liquid assets. These assets can be bought and sold in the financial markets without losing too much of their value. The liquid assets are favored by the investors as they can make good profits if they put their money in these assets.

The assets that have good levels of liquidity are:

Securities traded in money market
Blue Chip

Futures Market Liquidity
The assets that are bought and sold in the futures markets have different levels of liquidity. There are some assets that have greater levels of liquidity compared to other assets. The liquidity of the assets traded in the futures markets could be measured by using the following indicators:

Open Interest
Volume of Trading
Liquidity in Banking
Liquidity in the sphere of banking is different from liquidity in financial markets. In case of banking liquidity means that the bank is able to pay off the necessary obligations like paying off the dividends to stockholders for example. The banks that have comparatively higher levels of liquidity can perform this function without suffering from major losses.
Liquidity in Business
Liquidity in the business sector is more or less the same as liquidity in the banking sector. If a business entity can pay off the required obligations within the specified time, it is considered to have a certain amount of liquidity. It is assumed that if a bank is not able to pay its obligations at the right time it may be facing insolvency.
Importance of Liquidity in Business
Liquidity is an important concept in case of business sector. The business entities place a lot of emphasis on proper financial planning to make sure that any possibility of fund shortage is quickly detected.

In case of fund shortages it is seen that a company instructs its treasury department to generate funds for the upcoming business period. It has been seen that if the shortage of funds is not noticed earlier then the companies have to face bankruptcy. A similar situation takes place if a company does not have adequate funds.
Liquidation Sales
The business entities and merchants conduct liquidation sales. In these sales they sell inventories at a discounted price. The main aim behind this move is to generate cash. However, the businesses also want to do away with their inventories through the liquidation sales.

More Information Related to Finance Theory
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Long Terms Financing Yield Curve Arbitrage
Finance Services Company Arbitrage Pricing Credit Derivative
Binomial Options Pricing Model Capital Asset Pricing Model Cox Ingersoll Ross Model
Black Model Black Scholes Model Chen Model
Liquidity Risk Commodity Risk Consumer Credit Risk
Systemic Risk Currency Risk Market Risk
Interest Rate Risk Settlement Risk Equity Risk
Gordon Model Monte Carlo Option Model Ho Lee Model
Rendleman Bartter Model Vasicek Model Hull White Model
Rational Choice Theory Modern Portfolio Theory Cumulative Prospect Theory
Efficient Market Hypothesis Arrow Debreu Model International Fisher Effect
Floating Currency Financial Risk Management Hyperbolic Discounting
Personal Budget Floating Exchange Rate Discount Rate

Last Updated on : 1st July 2013

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