What does the term "liquidity" in financial markets refer to?

The term "liquidity" in financial markets refers to the speed and ease with which an asset can be converted into cash without causing a significant change in its price. This definition highlights two key aspects of liquidity: the conversion process should be quick, and it should occur with minimal price impact.

For instance, highly liquid assets, such as stocks of large, publicly-traded companies, can be sold rapidly in the market with little to no price concession. In contrast, illiquid assets, such as real estate or collectibles, may take a longer time to sell and could require substantial discounts to attract buyers quickly.

Liquidity is crucial for investors as it affects how quickly they can access funds and the stability of price valuations in financial markets. This concept distinguishes it from factors such as return on investments, risk levels associated with assets, or the available cash reserves of a company, which are not related to the ease of converting an asset into cash.