Liquidity in the Secondary Market
Liquidity is the ability or power of an asset to be converted into cash or near cash at the time needed without loss. Liquid asset is a readily marketable asset with a relatively stable price that is reversible. Perfectly marketable assets are called perfectly liquid assets. Whenever sold they suffer no price decline. Most securities have more money less than real asset but are not perfectly liquid assets like cash. That is, securities are more liquid than real asset but less liquid than cash and demand deposits at a bank. Investors pay a slightly higher price, called a liquidity premium for assets that are more liquid. Illiquid asset, on the other hand, are the assets that con not be sold quickly unless the seller incurs significant execution costs that include the following components:Liquidity in the Secondary Market
Price concession the seller must grant to the buyer to execute a quick sale.
The bid-asked spread, the size of which varies inversely with the liquidity of the subject security.
The compensation required to find the other party of the transaction.
Commissions of the brokerage firms.
In fine, liquidity of an asset is the ability to buy or sell the same quickly without causing any significant change in its price. Liquidity varies inversely with the costs incurred when buying and selling. Liquidity of a security increases as the volume of trading in it increases.
Features of a liquid market
Dealer and broker work together to create a liquid market as their work is easier and their cost of doing business is less in liquid markets.
However, the followings are the qualities that a liquid market must possess:
• Depth– being the position where buy and sell orders exist both above and below the price at which the security is trading. A market without depth is called a shallow market.
• Breadth-being a position where buy and sell orders exist in volume. Markets lacking the volume of orders needed to provide liquidity are called thin markets.
• Resiliency–where new orders pour in immediately in response to price changes caused by temporary order imbalances. A speedy price discovery process is essential for resilient.