Illiquidity can prevent businesses and individuals from generating enough cash to pay off their debts. For example, the Economic Times reported that Jet Airways had delayed the repayment of foreign debt for the fourth time “in recent months” due to a corporate illiquidity crisis that made it difficult for the company to access liquid funds. As a result, Jet Airways not only had to ground more than 80 planes, but also had to create a resolution plan that called for the resignation of its chairman Naresh Goyal and a vote by the board of directors to allow lenders to take control of the airline. Buyers, of course, fear price increases for things they want to own in the future. Sellers, on the other hand, fear price reductions. These mutual fears can lead to the creation of a financial instrument called forward. In a futures contract, buyers and sellers today agree on the price of an asset to buy and deliver in the future. This way, the buyer knows exactly how much he has to pay, and the seller knows exactly how much he will receive. You can sign a futures contract with your beer merchant that sets the price of your favorite beer at $25 per case, ensuring you have 4 boxes of good stuff by the end of the semester. Similarly, when planting, a farmer and a grocer could sign a contract to set the price of watermelons, corn, etc.
at harvest time. Illiquid securities carry higher risks than liquid securities, which is called liquidity risk, which is especially true in times of market turbulence, when the bid-to-ask ratio is unbalanced. In these times, holders of illiquid securities may not be able to unload them at all or do so without losing money. In addition, a company can become illiquid if it is not able to raise the liquidity needed to meet debt obligations. Exchanges such as the Chicago Board Options Exchange (CBOE), chicago mercantile exchange (CME), Chicago Board of Trade (CBOT) and Minneapolis Grain Exchange (MGEX) have developed futures contracts to avoid futures difficulties by: (1) effectively connecting buyers and sellers; (2) develop standardized weights, definitions, standards and expiry dates for widely used commodities, currencies and other assets; (3) Performance of contracts between counterparties. Each contract specifies the underlying asset (ranging from bonds to currencies, butter to orange juice, ethanol to oil and gold to uranium), its quantity and level of quality, as well as the type (cash or physical) and the date of settlement or expiration of the contract. CME, for example, offers a copper futures contract where the physical settlement of 25,000 pounds of copper is due on one of the last three business days of delivery month.www.cmegroup.com/trading/metals/base/copper_contract_specifications.html in many contracts, especially for financial assets, physical delivery is not desired or required. Instead, a cash settlement is made, which represents the difference between the contract price and the spot market price at the expiration date. Illiquid refers to the state of a stock, bond or other asset that cannot be easily and easily sold or exchanged for cash without significant depreciation. Illiquid assets can be difficult to sell quickly because trading activity or interest in the issue is low, which is indicated by a lack of investors or speculators willing to buy or sell the asset. As a result, illiquid assets tend to have lower trading volumes, larger bid-ask spreads, and greater price volatility.
Business illiquidity refers to a business that does not have the required cash flows for required debt payments, although this does not mean that the business is asset-free. Fixed assets, including real estate and manufacturing assets, are often valuable, but are not easy to sell when cash is needed. The sale of illiquid assets is not the core business of a company. They usually include all company-owned properties that are located outside of the products manufactured for sale. In times of crisis, a company may need to liquidate these assets to avoid bankruptcy and, if done quickly, it can sell assets at prices well below a fair and orderly market price, sometimes called a fire sale. Some examples of inherently illiquid assets include homes and other real estate, cars, antiques, private business investments, and certain types of debt. Some collectibles and works of art are often also illiquid goods. In terms of illiquid assets, the lack of willing buyers also leads to larger spreads between the bid price set by the seller and the bid price submitted by the buyer.
This difference results in much larger bid-ask spreads than would be found in an orderly market with daily trading activity. Lack of market depth (DOM) or ready-made buyers can lead to losses for holders of illiquid assets, especially if the investor wants to sell quickly. At the other end of the spectrum, most listed securities traded on major exchanges, such as stocks, ETFs, mutual funds, bonds and listed commodities, are highly liquid and can be sold almost immediately during normal market hours at a fair market price. In addition, precious metals such as gold and silver are often quite liquid. Trading outside of normal business hours can also lead to illiquidity as many market participants are not active in the market at these times. Stocks traded on over-the-counter (OTC) markets are also often less liquid than those traded on robust exchanges. While these assets may have inherent value, the market where they are sold often has few buyers compared to those who wish to buy more liquid assets. Agricultural futures contracts like the one just described have been used for centuries, if not millennia. Their use is limited by three main problems with futures: (1) It is often expensive/difficult to find a willing counterparty; (2) The futures trading market is illiquid due to their idiosyncratic nature, so they cannot be easily sold to third parties if you wish.
(3) A party is generally encouraged to break the agreement […].