Perpetual Knowledge Bank Series: Liquidity Risk

Light bulb

Perpetual Asset Management

printer icon Adobe PDF icon

Liquidity refers to an investor’s ability to sell a bond quickly and at an efficient price. This is determined by the difference between the bid − or the price at which the market is willing to buy the security − and the offer, which is the price at which the market is willing to sell the security. It is commonly known as the bid offer spread.

For example, if a small gap exists between the prices buyers are bidding and the prices sellers are asking on large, actively traded bond issues, then the market has low liquidity risk. However, as the spread rises on less actively traded bonds, so does liquidity risk. If a market is not liquid, it can become very difficult to trade without adjusting the price. The other factor that has an impact on liquidity risk is the volume which can be transacted at a particular price or bid offer spread. 

Generally, Australia’s benchmark government and semi-government bond issues are very liquid with investment grade corporate bonds more liquid than non-investment grade bonds. This is because bonds can have many variables which can reduce the number of suitable buyers, some of whom may be mandated to consider only investment grade bonds or certain types of securities. Portfolio managers control liquidity risk by constantly monitoring security prices and allocations to different security types. Prices that are out of line with comparable securities, or ‘stale’ prices that stay static for long periods, can be tell-tale signs of risks, including liquidity risk.

This information has been prepared by Perpetual Investment Management Limited (PIML) and may contain information contributed by third parties. It is general information and is provided for education purposes only. It is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider a range of material, and, if you consider necessary, obtain advice from a financial or other adviser, before making investment decisions in relation to your circumstances.

The information is believed to be accurate at the time of compilation and is provided by PIML in good faith. To the extent permitted by law, no liability is accepted for any loss or damage as result of any reliance on this information. PIML does not warrant the accuracy or completeness of any wording in this document which was contributed by a third party.