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LIQUIDITY AND CREDIT

LIQUIDITY AND CREDIT. LIQUIDITY INVOLVES A FIRM’S CAPACITY TO GENERATE CASH TO MEET CASH DEMANDS AS THEY OCCUR AND TO PROVIDE FUNDS FOR RESPONDING TO UNANTICIPATED EVENTS. BASIC PURPOSES OF LIQUIDITY. TRANSACTIONS:

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LIQUIDITY AND CREDIT

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  1. LIQUIDITY AND CREDIT LIQUIDITY INVOLVES A FIRM’S CAPACITY TO GENERATE CASH TO MEET CASH DEMANDS AS THEY OCCUR AND TO PROVIDE FUNDS FOR RESPONDING TO UNANTICIPATED EVENTS.

  2. BASIC PURPOSES OF LIQUIDITY • TRANSACTIONS: • DEMAND FOR LIQUIDITY THAT INVOLVES HAVING SUFFICIENT CASH AVAILABLE TO MEET KNOWN CASH DEMANDS ARISING FROM VARIOUS MARKET TRANSACTIONS ANTICIPATED TO OCCUR IN THE NEAR FUTURE.

  3. PRECAUTIONARY OR SAFETY: • THE DEMAND FOR LIQUIDITY IN WHICH CASH IS NEEDED FRO RESPONDING TO POSSIBLE ADVERSITIES IN THE BUSINESS OR HOUSEHOLD. • INVESTMENT: • DEMAND FOR LIQUIDITY IN WHICH FUNDS ARE NEEDED FOR RESPONDING TO NEW, UNANTICIPATED INVESTMENT OPPORTUNITIES.

  4. SOURCES OF LIQUIDITY • ASSET LIQUIDITY: • CURRENT ASSETS – THE MOST LIQUID BEING CASH AND NEAR CASH SUBSTITUTES. FOLLOWED BY INVENTORIES HELD FOR RESALE.

  5. AN ASSET IS CONSIDERED TO BE PERFECTLY LIQUID IF ITS SALE GENERATES CASH EQUAL TO OR GREATER THAN THE REDUCTION IN VALUE OF THE FIRM RESULTING FROM THE SALE OF THE ASSET. IN OTHER WORDS, ASSETS BECOME INCREASINGLY LESS LIQUID AS THEIR POTENTIAL SALE REDUCES THE VALUE OF THE FIRM BY INCREASINGLY MORE THAN THEIR EXPECTED SALES VALUE.

  6. REASONS FOR AN ASSETS SALE VALUE BEING LESS THAN ITS CONTRIBUTION TO THE FIRM’S ECONOMIC VALUE: • TRANSACTIONS COSTS • MARKET IMPERFECTIONS • URGENCY OF THE SALE

  7. LIQUIDITY RISK INVOLVES THE UNANTICIPATED VARIABILITY OF AN ASSETS VALUE OVER TIME • IN GENERAL, THE LESS VARIABLE AN ASSETS MARKET PRICE, THE GREATER IS IT’S LIQUIDITY • THE LIQUIDATION OF CURRENT ASSETS SHOULD NOT HAVE A SIGNIFICANT IMPACT ON THE INCOME GENERATING ABILITY OF THE FIRM.

  8. CREDIT RESERVES • A CREDIT RESERVE IS A SOURCE OF LIQUIDITY. • A FIRM’S CREDIT RESERVE IS REPRESENTED BY ITS UNUSED BORROWING CAPACITY. • THE DIFFERENCE BETWEEN THE MAXIMUM AMOUNT OF POTENTIAL BORROWING AND THE AMOUNT ALREADY BORROWED IS THE CREDIT RESERVE.

  9. IN GENERAL, CREDIT IS CONSIDERED A HIGHLY EFFICIENT WAY TO PROVIDE LIQUIDITY. • USING CREDIT DOES NOT DISTURB A FIRM’S BASIC ASSET STRUCTURE AND PRODUCTION ORGANIZATION. • TRANSACTIONS COSTS OF CREDIT ARE RELATIVELY LOW. • CREDIT IS GENERALLY AVAILABLE.

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