What is liquidity risk? What are the liquidity risks involved in an investment?

By Abhay Shah, Realty Quarter

Liquidity is the capacity of a firm, company, or even an individual to cover their debts without experiencing disastrous losses. Liquidity risk, on the other hand, stems from the lack of marketability of an investment that cannot be purchased or sold rapidly enough to avoid or minimize loss. It is typically expressed in exceptionally big runs of bid-ask or big motions of prices.

Five important things you should know about liquidity risk in investments:

1)Liquidity risk involves the difficulty of selling an investment when required or the cost for operations is less than the fair value of the asset, or there are premium costs required to carry out the transactions.

2)Some investments such as certain real estate and art investments have illiquid markets, as low volumes and high values characterize them.

3)Because of structural factors, the corporate debt market for retail investors suffers from the absence of liquidity and ready buyers are not accessible or a reduced cost may be quoted by an interested buyer.

4)Some instruments may have a low holding or lock-in period if no transactions are permitted or if there are costs such as bank FD and certain mutual funds.

5)Equity markets are deep and liquid. However, some companies are not frequently traded and are subject to liquidity risks.