How is 'liquidity' defined in finance?

Liquidity in finance refers to the ease with which an asset can be converted into cash without significantly affecting its market price. This is crucial for investors and companies because it impacts their ability to meet short-term obligations and respond to unforeseen expenses or opportunities. High liquidity means that an asset can be sold quickly and at a price close to its market value, which is vital for maintaining financial stability.

For instance, cash itself is the most liquid asset, while real estate properties are generally considered less liquid because selling them can take time and may involve price negotiation. Understanding liquidity helps investors make informed decisions about asset allocation and risk management.