Marketability versus liquidity

In the context of a market, the terms seem to be used interchangeably by the Institute and ActEd. For example, at the bottom of the ST5 notes page 13, ch 3: "... an investor could expect significantly higher returns from investing in corporate bonds than from investing in Treasury bonds... partly due to the impact of lower corporate bond *liquidity*"

However, CA1(1) examiners in April 2007 q 2 said:
"Marketability is the ability to trade an asset at a given price in given volumes.
It essentially relates to the ease of trading. For example how long it takes to deal and at what cost.
Liquidity is about how close to cash an asset is. It measures how soon the asset will turn into cash without being marketed. For example a seven-day fixed term deposit at a clearing bank might be completely un-marketable, because the deposit cannot be transferred or assigned. It is however extremely liquid. If market conditions change, liquidity is a measure of how the capital value moves. Liquid assets tend to have stable market values."

Therefore, should it not be *marketability* above, since we are necessarily comparing bonds of the same term - which will turn into cash at the same time – so liquidity is not an issue? If so, the examiners' comments below are somewhat hypocritical.

"Most candidates thought marketability and liquidity were synonyms, and struggled to find any difference between the two definitions."

I suspect the real answer is that the terms are sloppily defined.

For examples of *liquidity* used to mean both closeness to cash and marketability,
• in one camp we have liquidity preference theory definitions (short-dated stocks are more liquid since they turn to cash sooner than long-dated ones)
• and in the other camp the definition of liquidity risk in CA1 (capacity of a market to handle traded volume when required) and the Wikipedia page on market liquidity (“A liquid asset has some or more of the following features. It can be sold (1) rapidly, (2) with minimal loss of value, (3) anytime within market hours.”)

 

Strictly speaking:

(1) An asset is marketable if it can be sold quickly, cheaply and easily - i.e. with low expenses and little impact on the market price.

(2) An asset is liquid if it is marketable and it has a stable market price. (This is because liquidity refers to the speed and certainty with which an asset can be converted into cash.)

So, whereas all government bonds are marketable, short-term government are also liquid (as they have a low volatility and a stable market price), whereas long-term government bonds are illiquid (as they have a high volatility and an unstable market price). Hence, the liquidity preference theory (i.e. investors require a higher return on long-term bonds to offset lower liquidity, all else being equal).

However, and as you note, people often fail to distinguish carefully between the two concepts in practice.

 

I don't mean to rock the boat too much but I would have thought that Graham's definition for liquidity in parenthesis was the "Correct" one, rather than being both marketable and having a stable price.

I think that 99% of the time the two terms are used interchangebly (as the difference is very subtle)

"For example a seven-day fixed term deposit at a clearing bank might be completely un-marketable, because the deposit cannot be transferred or assigned. It is however extremely liquid." gives an example of liquidity but not marketable (perhaps the only one).

Dan,
I agree that the terms are slopily defined, so much that even an ActEd tutor (no offence to Graham) has offered an apparently contradictory defination.
In terms of whether "liquidity" should be replaced by "marketability" in the notes, to me it doesn't matter. Both marketability and liquidity are involved here pretty much for the same reasons and have the same consequences.

I think that your comment that the liquidity is the same as you get cash from each bond at the same time, is incorrect. Liquidity is more to do with the ability to change into cash in the very short term, whereas those bond payments may not occur for many years.

Anyway, these comments are merely my (layman's) opinion - so only take them into account at your own risk

 

I'm just hoping that a 15 mark essay on "explain the distinction between 'liquidity' and 'marketability' doesn't come up in this time's ST5 exam as I'm now confused, and I think that fail number 4 would be on its way to blocking my qualification this time around!

 

My apologies if my views have caused anyone confusion - they are just that, my views.

However, I believe that this area is one where there is a lot of potential confusion (whether it would matter for either real life, or in passing the exams is another debate) and hence we may as well put all the different opinions out on the forum for everyone to decide themselves which is correct.

When this question came up in CA1, it was only worth a handfull of marks, and I managed to pass. I was certainly surprised to see that the examiners thought it surprising that students don't know the difference. I hope for your sake that no 15 mark questions on this ever arise.

 

Re. my above definition of liquidity:

(2) An asset is liquid if it is marketable and it has a stable market price. (This is because liquidity refers to the speed and certainty with which an asset can be converted into cash.)

I don't think that the definition before the parenthesis contradicts the definition within the parenthesis. What I was trying to convey is that:

If an asset can be converted into cash speedily (and cheaply), then it is marketable.

If, in addition, the asset can be converted into cash with certainty (i.e. into a known or reasonably certain cash amount, which is the case if it has a stable market price that isn't changing (possibly materially) every few minutes or even seconds), then it is also liquid.

Hopefully, this is a little clearer.

 

I'll try to be a little clearer myself. The part before the parenthesis is not contradictory with the part inside. I just thought the second seemed "better" because of the following.

I meant that the part before the parenthesis is contradictory with the example given by the CA1 examiners report quoted below.

ie
"an asset is liquid if it is marketable and.."

and

the example "7day fixed deposit is completely unmarketable, yet liquid"

IN MY OPINION these are contradictory as the first implies that you need marketability for liquidity as a necessary (but not sufficient) condition. The second is a counter example to this.

Perhaps I'm wrong, the examiners are wrong (with their example) or there is simply no right answer (as is often the case).

 

I agree that a 7-day fixed deposit seems unmarketable (as you cannot sell it in a marketplace and it takes a week to convert it into cash) and hence it ought to be considered illiquid (despite having a stable value).

My understanding is that:

1. An asset cannot be liquid and unmarketable - marketability is a necessary, but not sufficient, condition for being liquid.

2. 7 days to get the cash is not speedy. Yes, it typically takes longer than that to sell some (unquoted) assets, but quoted financial securities can typically be sold / converted to cash in a matter of seconds (albeit, you then might have to wait a day or two for the cash to clear/be settled).

In practice, however, and probably also in the ST5 exam room, I don't think that the exact definitions of marketability and liquidity are likely to be that important.

 

1) From today's FT

Regulators have accused banks of misrepresenting ARS as liquid, cash-like instruments... (Article title: Bank trio in auction rate deals)

So the author seems to go with liquidity = closeness to cash.

2) If liquidity = marketability + stable market price, and marketability implies that there is someone willing to trade, but trading introduces volatility, then how can we have a stable asset value?

The awkward student might say: an untraded instrument like my house has an almost flat price over time, but a popular instrument - like T-bills - would have a more volatile price. (Even if I sold my house in 10 year's time and got a different price for it than I paid, the standard deviation of price over time would be lower than T-bills over the same period.)

Clearly, my house is not more liquid than T-bills because it is not marketable. So I think I am starting to understand Graham's distinction. In which case, saying something is liquid and marketable is redundant?

 

Thanks Didster, Graham and Dan

Your explanations and examples have helped me (sort of) get my head around this one! Good luck!

 

Hey, I wanted to open this up again. I'm doing CA1 and I'm still struggling to understand the differences between liquidity and marketability.

In regards to Graham's points above, this is copied from the CA1 Core Reading:

"For example, specialist firms are frequently prepared to purchase residential property immediatel, but at a large discount to the "market" value. Because these firms exist, residential property could be described as a marketable asset, but not a liquid one, because of the adverse impact of a forced sale on the price.

For example, a seven day fixed term deposit at a bank is a highly liquid asset - it will become cash within a week. However as such deposits cannot be cashed early or assigned to a third party, they are completeyly unmarketable."

So is marketability just how easy something is to sell, and liquidity is how quickly the asset will become cash?

 

Graham is right is saying that liquidity comes from additional dimension of 'stable price' to dimensions of marketability i.e. there is a market place where the asset can be sold cheaply, easily and quickly.

However, there are exceptions to it. For e.g. savings accounts, 7 day bank deposit. For these assets technically there is no market where they can be sold however they are still considered as liquid because they can be converted into cash with a stable price.

Hope this helps.

Cheers!

 

Awesome! Now I see