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What does 'Illiquid' mean

Illiquid refers to the state of a security or other asset that cannot easily be sold or exchanged for cash without a substantial loss in value. Illiquid assets may also be hard to sell quickly because of a lack of ready and willing investors or speculators to purchase the asset. Additionally, a company may be deemed illiquid if it is unable to obtain the cash necessary to meet debt obligations. Illiquidity is the opposite of liquidity.

In regard to illiquid assets, the lack of ready buyers also leads to larger discrepancies between the ask price, set by the seller, and the bid price, submitted by the buyer, leading to much larger bid-ask spreads than would be found in an orderly market with daily trading activity. This can cause holders of illiquid assets to experience losses, especially when the investor is looking to sell quickly. Illiquid assets also typically lack depth of market.

Illiquidity in the context of a business refers to a company that does not have the cash flows necessary to make its required debt payments, though it does not mean the company is without assets. Capital assets, including real estate and production equipment, often have value, but are not easily sold when cash is required. Sales of these illiquid assets are not a company’s core business, and generally include any property owned by the company that is outside of the products produced for sale. In times of crisis, a company may need to liquidate these assets in order to avoid bankruptcy, and if this is done rapidly it can lead to disposing assets at prices far below an orderly fair market price, sometimes known as a fire sale.

BREAKING DOWN 'Illiquid'

Examples of Illiquid and Liquid Assets

Some examples of inherently illiquid assets include houses and other real estate, cars, antiques, private company interests and some types of debt instruments. Certain collectibles and art pieces may be considered illiquid assets as well. Stocks that trade on over-the-counter (OTC) markets are also often less liquid than those listed on robust exchanges. Though these assets may have inherent value, the marketplace in which they are sold often has few buyers in comparison to those interested in the purchase of more liquid assets.

On the other end of the spectrum, most listed securities traded at major exchanges - such as stocks, ETFs, mutual funds, bonds and listed commodities - are very liquid and can be sold almost instantaneously during regular market hours at fair market price. Additionally, precious metals, such as gold and silver, are often fairly liquid. Trading after normal business hours can also result in illiquidity because many market participants are not active in the market at those times.

An asset's liquidity may change over time, depending on outside market influences. This is especially true for collectibles, as an item's popularity in the consumer market may fluctuate dramatically, leading to highly volatile pricing.

Illiquidity and Risk

Illiquid securities carry higher risks than liquid ones, known as liquidity risk, which becomes especially true during times of market turmoil, when the ratio of buyers to sellers may be thrown out of balance. During these times, holders of illiquid securities may find themselves unable to unload them at all, or unable to do so without losing a lot of money. Illiquid securities also may demand a liquidity premium added to their price in order to compensate for the fact that they may difficult to dispose of later on. During times of financial panic, markets and credit facilities may seize up, causing a liquidity crisis, when sellers of even marketable securities find it difficult to find eager buyers at fair prices.

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