Illiquid (Assets) - Explained
What are Illiquid Assets?
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What are Illiquid Assets?
Illiquid, as a term, is used to identify assets or securities that cannot be disposed of quickly by way of sale. Also, it refers to a business/enterprise that doesn't have enough funds to meet its obligations. The illiquidity of the business may lead to bankruptcy because -- as a company can exist without profit but not without funding for operations.
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How are Illiquid Assets Used?
Illiquidity is a business terminology that refers to a firm that lacks enough cash flow to make payments for their debt. Although the company has other fixed assets like machinery building and land, these assets are illiquid and selling them is not a core part of the business operation. Selling of illiquid assets only arises in time of severe financial crisis; however, if not done on time, there will be a likelihood of a fire sale, whereby the asset fetches lower price compared to prevailing market valuations. Illiquid assets usually attract large differences between ask price, set by the seller, and the bid price, submitted by the buyer. With larger spreads than in a competitive sale, the illiquid asset typically loses value in a quick deal. The loss is due to the company having a limited alternative due to lack of purchasers for value or willing investors to take up the asset. Nevertheless, the liquidity of such assets changes with market influence; for instance, collectibles items value may fluctuate over time due to popularity. Several assets can be classified as illiquid because they are not commonly traded;
- Over-the-counter (OTC) markets Stocks such as; penny stock, nano-cap and micro-cap stocks.
- Shares in private companies.
- Houses and other real estates
- Collectibles such as antiques and classic arts.
- Partnership shares in hedge funds.
- Some types of bonds and debt instruments.
- Also, some types of futures, forward contracts, and options.
Determining the real market value of these assets may be challenging. Liquid assets, on the other hand, can easily be disposed off by way of sale during a regular trading hour and will often attract the current market value. Examples include;
- Listed stocks.
- Mutual funds.
- Commodities listed for exchange.
- Precious metals (gold and silver)
Trading these assets other than during regular market hours may lead to illiquidity since there is minimal market participation and trading is inactive; therefore its hard to make a sale.