Market liquidity refers to the ease of selling an investment without affecting its value. Factors affecting liquidity include trading activity, bond rating, maturity date, and investment fund. Short-term bonds, highly rated securities, and those with an investment trust are more liquid. Foreign investments also have varying degrees of liquidity due to laws governing redemption. Liquidity risk is the possibility of a security not selling or being sold at a loss. Money market instruments and US Treasuries are generally liquid, while real estate and bank certificates of deposit are illiquid.
Market liquidity refers to the ease with which a security, or investment, can be sold and converted into cash without having a major impact on value or price. If a stock is liquid, it means an investor may have immediate access to cash as the investment can be sold quickly at a fair market price. The level of market liquidity can be affected by the amount of trading activity associated with the security, as well as other factors such as the bond’s rating, maturity date, and the existence of an investment fund. Foreign investments have varying degrees of liquidity due to the laws governing the redemption of shares from other countries. Market liquidity is also related to liquidity risk, which means that a security may not 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 affect liquidity as some investors will only buy highly rated securities. Those with a short time to maturity are more liquid than long-term securities. The coupon rate, current market value, issuer, and any calling features can determine how attractive a security is to buyers, which in turn affects liquidity. If the issuer has established an investment trust, it typically makes the bonds more liquid because it allows the trustee to set aside cash to redeem the bonds, call them, or repurchase them on the open market.
Foreign investment also has factors affecting market liquidity. The hours during which a foreign market is open for trading can vary and may be different from market hours in an investor’s country of residence. The size of foreign markets can also play a role in liquidity. Also, some countries restrict the foreign countries from which investments can be purchased. There may also be laws restricting the return of money to the home country from a sale of foreign investments.
Some types of investments are generally considered to have high market liquidity, while others are generally considered to be illiquid. For example, money market instruments are generally liquid as they have a year or less to maturity. Many US Treasuries and bonds are liquid because they usually have numerous buyers and sellers at any one time. On the other hand, real estate and bank certificates of deposit are illiquid because they cannot be sold quickly or easily converted into cash.
Investors interested in market liquidity should also be aware of liquidity risk. This type of risk is the possibility that a stock will rarely or not sell at all. In some cases, a security may only be able to sell at an exceptional discount or at a loss of principal. Liquidity risk can also refer to an issuer not being able to pay the full amount of the debt obligation on the maturity date.
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