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Let’s calculate these ratios with the fictional company Escape Klaws, which sells those delightfully frustrating machines that grab stuffed animals. For example, a technology company does not operate the same as an airline company. The tech firm might need to buy computers and office space, while an airline needs to buy planes, a large labor force, and jet fuel. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

Pricing for crypto tends to be more volatile than other assets, affecting pricing predictability and reducing liquidity. Stablecoins pegged to fiat currencies, or cash, have been designed to be more liquid cryptocurrencies. Generally, investors concern themselves more with market liquidity, as the ability to trade assets quickly can be crucial. Additionally, when you’re saving up for specific goals, it’s wise to know how quickly you can access the cash value of your savings without decreasing their value.

Balance Sheet Assumptions

Correspondingly, the firm’s senior management is responsible for developing and implementing a liquidity risk management strategy. The strategy should include specific policies on such issues as the composition of assets and liabilities, especially regarding maturity, and the diversity and stability of funding sources. The strategy should take account of liquidity needs under normal conditions as well as during periods of liquidity stress. The strategy must be communicated to all business units that have an impact on the firm’s liquidity position. In particular, liquidity costs and risks should be incorporated into both on- and off-balance-sheet product pricing. This approach should align the risk-taking incentives of individual business units with the liquidity risk their activities create for the entire firm.

As awareness of fractional alts investments increases, we will likely see the liquidity of these investments increase as well. Other more financial alternative asset classes, such as private equity or hedge funds, typically have low liquidity because these funds impose steep restrictions on their investors. These restrictions include lock up periods or redemption notices, where investors must notify fund managers weeks or months in advance in order to withdraw funds. Stock options offered by startup employers are another example of an illiquid financial asset.

How is liquidity measured?

All else being equal, more liquid assets trade at a premium and illiquid assets trade at a discount. Market liquidity and accounting liquidity are two main classifications of liquidity, and financial analysts use various ratios, such as the current ratio, quick ratio, acid-test ratio, and cash ratio, to measure it. Having liquidity is important for individuals and firms to pay off their short-term debts and obligations and avoid a liquidity crisis.

An inability to acquire such funding within a reasonable timeframe could place a firm at risk, as graphically shown by the recent demise of certain investment banks and other financial institutions. In particular, the Basel Committee on Banking Supervision What is Liquidity (BCBS) recently reviewed and expanded its survey of sound practices for liquidity risk management by both banking organizations and their supervisors. This Economic Letter reviews and highlights key elements of liquidity risk measurement and management.