Few financial executives have a firm grasp of what liquidity means in a portfolio of individual cash assets.
The two main criteria in measuring liquidity are: 1. how long it takes to convert an asset to cash, and 2. how much of a price “haircut” must be taken on the sale.
The Top 10 Liquidity Factors may provide useful tools during the security selection process.
Additionaly, investors may benefit from the Six Steps to Better Liquidity in portfolio construction decisions.
While no one can pinpoint when the next market liquidity event may occur, portfolio liquidity management in times of smooth sailing is certainly within the control of the cash investor.
Financial executives often consider liquidity as a major investment objective for their excess cash accounts. Few, however, have a firm grasp of what liquidity means beyond daily access to a money market fund. This is especially so in a portfolio of individual cash assets. As the Federal Reserve aggressively mops up excess liquidity from the financial system, now could be a good time to fine tune liquidity in your portfolio.
What is Liquidity and how to Measure Liquidity?
Liquidity can be different things in different situations. This article addresses a portfolio of supposedly liquid investments that a typical treasury account may keep for planned and unanticipated cash needs.
With marketable cash investments, liquidity generally means how easily and quickly one may exchange a security for cash with little price concession from its going rate. Using this definition, cash currency and demand deposits at financial institutions are certainly liquid. How, then, does one discern other types of cash assets?
The two main criteria in measuring liquidity are: 1). how long it takes to convert an asset to cash, and 2). how much of a price “haircut” must be taken on the sale. Sellers of Treasury bills and corporate commercial paper with Prime-1 credit ratings often can receive cash payments on the date of the transaction, and at a price very close to the dealer-quoted price. By contrast, a bank certificate of deposit usually does not qualify as a liquid asset. An investor either waits until the CD’s maturity date to withdraw funds, or pays a substantial penalty for early withdrawal. The liquidity of other cash instruments falls somewhere in between.
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