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Liquidity refers to the ease and speed at which an asset or investment can be converted into cash without significantly affecting its price.
What is liquidity?
Assets that are highly liquid can be quickly sold or traded in the market with minimal impact on their value. On the other hand, assets with lower liquidity may take more time to sell and could potentially incur a greater loss in value during the process.
In the financial context, cash is considered the most liquid asset as it can be used immediately for transactions. Other highly liquid assets include stocks traded on major exchanges and government bonds. Real estate and certain types of investments, on the other hand, tend to have lower liquidity as they may take longer to sell or convert into cash.
Example of liquidity
XYZ Corporation is a manufacturing company that produces electronic components. The company operates in a dynamic industry with fluctuating demand and supply chain challenges. As part of its financial management strategy, XYZ Corporation ensures it maintains a healthy level of liquidity.
XYZ Corporation keeps a portion of its assets in the form of cash reserves in its business accounts. This ensures the company has immediate access to funds for day-to-day operations. In addition to cash, XYZ Corporation holds marketable securities, such as short-term investments in stocks and bonds.
The liquidity of XYZ Corporation provides operational flexibility. In the face of unexpected expenses, changes in market conditions, or opportunities for strategic investments, the company can quickly access the necessary funds without disruptions to its core operations.
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