You’ve been hearing the term a lot recently, as the Federal Reserve and the rest of the government has injected liquidity into the economy.
Let’s start with a definition. Liquidity is a measure of how quickly an asset can turn into cash.
That sounds esoteric. Don’t worry. TheStreet will walk you through.
Stocks are liquid assets. They’re traded on formal exchanges and you can find a buyer very quickly to sell to and turn that asset into cash. On days when it’s hard to find a buyer because investors are selling stocks in fear of poor fundamentals, you may have to sell your stock at a lower price. In that case, your liquidity position in your stock portfolio declined that day.
Houses are less liquid. It can take months to find a buyer.
A company's manufacturing equipment is incredibly illiquid. It makes things and produces results, which yield cash, but that takes time. And selling a machine would take time. Plus, it depreciates and loses value.
What about a company’s liquidity position? That’s been in focus in 2020, as the Coronavirus and social distancing has cut off consumer and business spending, making revenues vanish. Now, companies’ debt — even their low interest short-term debt — is less creditworthy because they aren’t producing cash flows with which to pay down that debt.
So yes, companies have cash on hand (cash is the most liquid asset because it’s already cash), but the company’s short-term position isn’t so liquid. They have liabilities staying steady and they aren’t growing their cash pile. So their short-term assets, like cash, compared their short-term liabilities, like some debt and payables, is minimal.
In steps the Fed.
To see the how the Fed plays a role in liquidity conditions in the economy and market watch the quick video above.
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