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Liquidity and Marketability

S

SpringbokSupporter

Member
What is the difference between liquidity and marketability? Is it as follows:
Liquidity - Stable Market Values
Marketability - There are many buyers and sellers
 
Official distinction from the 2009 Core Reading:

It is important to distinguish liquidity from marketability:

● Marketability is how easy it is to convert an asset into cash. The amount of cash received is unimportant.

● Liquidity is a measure of how long it will take for an asset to become cash.
 
Is that quote from the 2009 reading also in the 2008 reading? Haven't seen it before. In the 2008 reading, it's a bit confusing because it talks about a market context of liquidity risk where a "market does not have the capacity to handle (at least, without significant adverse impact on the price) the volume of an asset to be bought or sold at the time when the deal is required".

Marketability is explained in the ActEd solution to CA1 Paper 1 April 2007 as meaning that "an asset can be quickly and easily bought and sold at the desired price and in the desired volumes."

(unfortunately, by saying 'quickly here, this seems to combine what the 2009 core reading says about marketability with what is says for liquidity.)
 
Anna Bishop said:
Official distinction from the 2009 Core Reading:

It is important to distinguish liquidity from marketability:

● Marketability is how easy it is to convert an asset into cash. The amount of cash received is unimportant.

● Liquidity is a measure of how long it will take for an asset to become cash.
Click to expand...


I don't understand what the distinction is.

Both appear to say that they are measures of the time taken to sell the asset for cash.

Could someone please provide an example asset which is only one of liquid/marketable - perhaps that might help?
 
Just to muddy the waters a little, the definition of marketability/liquidity in the 2009 Core Reading was not my understanding of the terms. To quote from a paper on marketability/liquidity issued by Hidetoshi Takeda of the International Monetary Fund (available at http://www.imf.org/external/np/sta/bop/pdf/resteg4.pdf):

"Further, it is worth noting that market participants may interpret "marketability" different from "liquidity", in that the former implies the ability to buy and sell the instrument with minimum time and cost, whereas the latter also implies the ability to buy and sell without unduly affecting the value of the security."

In fact, I used the above definition in my ST5 exam last session. So, I interpret the set of liquid assets to be a subset of the set of marketable assets, with the extra condition that selling doesn't unduly influence value. To be clear on this: according to this definition you cannot then have an asset which is liquid but not marketable.

The "InvestorWords" source at http://www.investorwords.com/2963/marketability.html also seems to agree with this.

Do we know what the source is for the Core Reading definition? A peer-reviewed source for this definition would be ideal.
 
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marketability - ease of trading

liquidity - how close asset is to cash, i.e. volatility

so talk about trading issues when assessing marketability, and talk about how close asset is to cash by analysing its volatility when assessing liquidity (higher the volatility, further the asset is from cashing out)
 
I think the usual answers are:

:rolleyes: Equities are marketable, but not liquid. They can easily be traded, but do not have stable values.

:rolleyes: Short-Term deposits are seen as liquid, but not marketable.

Some discussion is useful:
Cash is the 'ultimate' liquid asset, but is obviously not marketable. Any close substitute to cash is also liquid, even if it is not marketable.

If an asset is marketable and stable in value, then there is not much difference between holding this asset and holding cash, so this asset will be liquid.

Consider the notes on CIVs. Unit Trusts are said to guarantee marketability, not liquidity. This is because the Units can always be cashed in at short notice, but their values are not guaranteed - therefore they do not behave like cash and are not liquid.

Interesting choice of words, I think, since Units cannot be bought and sold between investors and are therefore not marketable in the usual sense. So can we really say Units in a Unit Trust are marketable, but the term deposit isn't, as we did in the example above?

This is why I tend to like the idea that liquidity = marketability + stable values, where marketability is taken in the unit-trust sense. (but can short-term bonds that cannot be bought and sold easily be considered marketable because they can be redeemed in the near future. Again a direct consequence of accepting that Units in a Unit Trust are marketable).

You could say that assets can be considered as having two features relevant to marketabiliy - ability to be traded and ability to be cashed in. One additional feature is required for liquidity and that is stability in value.

Finally, tying this in with the "closeness to cash" concept. As asset can only behave in a similar way to cash if it is marketable in at least one of the above senses, and is also stable in value.

There's a post on the ST5 forum about this, which you might want to look at.
 
You may also find the solution to CA1 Paper 1 April 2007 Q2 useful.

As tutors, we've been round the houses on this issue several times. And it would appear that wherever you look: Core Reading, CA1, ST5, wikipedia, other sources etc that the definitions vary. No-one can agree!

For what it's worth, here's my take on the issue:

Marketability means that an asset can be quickly and easily bought and sold in the desired volumes, ie there are many buyers and sellers, who frequently trade in the asset.

Liquidity means that either an asset is similar in nature to cash or can be quickly converted to cash without loss of value (ie it is not volatile).

This seems to tie in with the implications of the CA1 course, for example

Money market instruments - term deposits are liquid but not marketable as you can't sell them!

Liquidity preference theory - long-term Gov bonds are less liquid (ie more volatile) than short-term bonds, although both are very marketable.

Unit trusts - good marketability (in general) as trust obliged to buy back units, although note recently in UK that property unit trusts have been struggling to do this - currently long delays in redeeming units.

I'm not sure we can say that liquidity = marketability + stable market values. I used to think this but it can't be true since there are examples of assets that are marketable but not liquid (long-term bonds) and liquid but not marketable (term deposits).

Anna
 
Anna Bishop said:
... there are examples of assets that are marketable but not liquid (long-term bonds) and liquid but not marketable (term deposits).

Anna
Click to expand...

Not sure if I'm convinced. If long-term bonds are marketable, i.e. if they can be traded easily, doesn't that make them liquid (can be converted to cash quickly)? If I can easily trade a long-term bond, doesn't that mean I can sell it quickly to convert to cash quickly?
 
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You are correct in saying that long-term bonds are marketable (in most developed countries). The issue sizes are huge and there are many buyers and sellers.

Try this example for why they would be considered less liquid than shorter term bonds:

Consider 2 bonds both redeemable at par:

A) a 1-year ZCB and
B) a 30-year ZCB.

Here are the prices of the two bonds:

P(A) = 100/(1+i)
P(B) = 100/(1+i)^30

A change in government policy or interest rates then results in a shift in the bond yield curve by half a percentage point.

Which bond changes in price/value the most?

B will - test this out with some numbers if you're not convinced!

So longer-term bonds are more volatile in value and this makes them less liquid.
 
For the solution to Sep06 Paper 1 Q6(iii) in ASET it states as one of the risks of Corporate bonds, "Corporate Bonds are generally less marketable than some assets (e.g. government bonds, equity in blue-chip companies), which may be a risk for investors who need liquid assets".

This seems to imply that these investors would prefer to hold government bonds or blue-chip equities. I would have thought these assets would be quite illiquid (especially if the bonds are long-term). Is this a case of marketability and liquidity being mixed up again or am I missing something?
 
I think the solution is saying if corporate bonds are not marketable because they might take a while to sell, then neither are they liquid since liquidity means "can be converted to cash quickly without loss of value".
 
Just to add to Anna's response: Corp bonds would be more volatile due to its smaller issue size (supply) compared to govt bonds. If the same quantity of govt and corp bonds are traded, corp bond price change would be more noticeable. So there's prive uncertainty. If you are the trader in question, you could make a loss due to
1) liquidating corp bond way too early
2) price volatiliy

It doesnt mean that 2) is always loss, it could be a profit too. But being actuaries, skeptisism is the order of the day....
 
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