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What is Liquidity 2021? What Are The Types Of Liquidity? – Introduction to Forex

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What is Liquidity 2021? What Are The Types Of Liquidity? - Introduction to Forex

What is Liquidity 2021? What Are The Types Of Liquidity? – Introduction to Forex

Liquidity is a concept that deals with the magnitude of the change between an asset’s selling rate and its salable price. Financial assets of individual or institutional investors, the nature of the markets where they can sell without a significant change in price, liquidity is associated with. Assets that can be sold quickly without any change in the liquid market and value of these types of markets are also called liquid assets.

What Are Liquidity Examples?

Examples of liquidity The first to come to mind are financial products that can be quickly converted to cash. The first example that can be given to liquid assets is cash. Cash can be easily converted to a different investment instrument or a different currency. Liquidity examples can be reproduced as follows:

  • Stock
  • Bond
  • Commodity
  • Real estate
  • Vehicle

What Are The Types Of Liquidity?

Liquidity types are financially divided into two different types:

  • True Liquidity: Identifies the assets that can close all debts in the fastest and easiest way in case the firm is liquidated. It is used to measure the ability of the firm to pay off its debts if it sells cash and other liquid assets that can be converted into cash.
  • Technical Liquidity: It measures the firm’s ability to pay its due debts. While cash is in the first place, the process of payment of debts that are due falls under the definition of technical liquidity.

What is the Liquidity Effect?

Liquidity effect It is a concept that expresses the increase in purchasing power. This concept, which defines the increase in real income due to the fact that the increase in money supply is not reflected in prices, is closely followed due to the increase in real income during the period causing inflation.

What is Liquidity Trap?

Liquidity trap refers to the elasticity of the demand for money in times of low interest rates. As it is known, there is an inverse proportion between the interest rate and the demand for money. When the interest rates increase, the demand for money decreases due to the cost that will increase.

Interest rates When low, savings rates increase. Since consumers see an opportunity because they expect an increase in interest rates, they tend to save by avoiding bonds. The reason for avoiding bonds is the inverse ratio between the interest rate and the asset price. An increase in bond interest means that its price will decrease. This situation, which is encountered because the savers do not want to keep the assets that are expected to decrease in price, is called the liquidity trap.

The signals of the trap are low interest rates, as can be seen in the example shared above. Investors’ selling positions due to the expected downward trend in bill and bond prices affect the economy badly. In the period of abundant liquidity, while investment in risky assets increases, the liquidity preferences of the asset also increase. This situation, which causes a negative change in the money supply, negatively affects the dynamics of the economy as we have mentioned. The need to change interest rates arises to make this process normal.

What is Liquidity Risk?

Liquidity risk It is a concept that expresses specific risks related to banking and deals with asset-liability management. The inability of banks to control risks by reducing their liabilities liquidity Risk refers to the lack of resources to cover the increase in banks’ assets.

What is Liquidity Preference Theory?

Liquidity Preference Theory was introduced to the literature by John Maynard Keynes and after 1936 it was used instead of Quantity Theory to explain the demand for money. With his theory, Keynes added the need for speculation to the demand for money, and according to the theory, the motives affecting the demand for money were finalized as follows:

  • Processing Motive: The transaction motive, which is a function of the income level, expresses the willingness to keep money in order to meet daily needs.
  • Prudence Motive: The prudential motive, whose income level is a function, refers to the desire to hold money in order to stay on the safe side in extraordinary situations. The incentive to hold money against the treatment expenses due to a sudden illness, the education of children and the expenses to be encountered during the retirement period can be called the prudent motive.
  • Speculation Motive: The speculation motive, defined as a function of interest, defines the willingness to hold cash for the purpose of profit from future investment opportunities.

What Is The Liquidity Ratio? What Does It Mean?

Liquidity ratios These are the ratios used in the analysis method named “Fundamental Analysis” performed in stock markets and used to analyze the financial structure of the company. As it can be understood from the definition, there is no single ratio used to measure liquidity, more than one ratio is included in the concept mentioned. ExchangeThe liquidity ratios and calculation methods, which can shed light on the current financial conditions of the companies traded in the company, and their expectations in the upcoming period are detailed below:

  • Current rate: It expresses how much of the company’s short-term debts (maturity less than 1 year) can be covered by current assets. In its calculation, the current ratio value is reached by dividing the “Current Assets” item in the balance sheet into the “Short Term Liabilities” item. While 2 is considered ideal for the ratio, the value between 1 and 1.85 is also acceptable.
  • Acid-Test Ratio: The use of “Inventories” item in the formula in the current ratio calculation may cause problems for companies with low stock turnover. The acid-test ratio developed to overcome this problem, when the company’s stocks are excluded, the relationship of current current assets is examined in order to meet its short-term liabilities. Acid-Test ratio formula was created by subtracting the “Inventories” item from the “Current Assets” item and then dividing it to the “Short Term Liabilities” item. For the ratio, a value of 1 and above is considered very good, while the acceptable level band is accepted as 0.60 – 1.00.
  • Cash Ratio: The cash ratio, which is shown among the strictest liquidity ratios, is used to measure how much cash is in the company’s safe to pay off its short-term liabilities. In the cash ratio calculation, which is considered the most liquid financial ratio, the formula prepared by dividing the “Cash and Cash Equivalents” item in the balance sheet into the “Short Term Liabilities” item is used. For the cash ratio, values ​​of 0.50 and above are considered very good, while the acceptable level is set as the 0.20 – 0.50 band.

What is the Most Liquidity Asset?

The most liquid asset is cash. As can be understood from the definition, the conversion of assets to cash is measured by their liquid structure. Cash money is currently at the liquid level that is aimed to be converted. On a company basis, cash is the most liquid asset, while the assets with the lowest liquidity are inventories.

What is the Importance of Liquidity?

The importance of liquidity It can be easily converted into cash. Investors must also pay attention to the liquidity of the asset they will invest with with potential earnings. Because, in order to be able to utilize an opportunity that may arise periodically in a different investment instrument, an asset with less potential should be obtained quickly. The more liquid the owned assets are, the faster the transition to the other enabling asset will be made by selling.

The logic of investing is to make a profit. Making a profit sometimes requires being able to seize the opportunities that may be encountered. Chasing opportunity by always staying in cash means missing out on most of the earnings. Therefore, no matter what asset they invest in, investors should definitely check the liquidity of the asset; Even if they will include an illiquid asset in their portfolio, they should limit the ratio of the asset in the portfolio.

When considered on the basis of companies, the importance of the concept is also important for the investor in addition to the future of the company and its healthy activities. The liquidity of the company increases the assets section and facilitates the financing of the resources section.

Companies whose due debts are paid on time and continue their activities in a healthy manner are also important companies in the eyes of investors. Companies can find easy and cheap resources for their investments, and it can be thought that they have gained the ability to pay off their debts if they are liquidated. Liquidity As can be understood from the explanation above, the concept appears as an important definition that needs attention in many areas from the economy of the country to investment.

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