Empirical measurement of liquidity, Financial Management

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Empirical Measurement of Liquidity: The number of days a particular share is being traded reflects the liquidity of the market. If it is traded actively on 50% of the days when the market is open, then it is termed as liquid. The variation in price of the share from one trading day to another also determines the liquidity of the share. The market is said to be shallow, if there is a wide gap between the lowest asked price and the highest bid price. The bid-ask difference is an inverse measure of liquidity. In the United States, one-eighth point of variation in price from preceding trade is taken as liquid market share. But in India, the minimum tick starts from 0.25.

Determination of Fair Price: Usually, the forces of demand and supply determine the price of the share. When the prices are going up, it is termed as a bull phase and when the prices are going down it is termed as a bear phase. At times large-scale speculatory activities raise the price of the share. But such activities are ephemeral in nature. There is no fundamental relationship between book value, par value and market value of the share, because the share price may experience a boom if there is large-scale investment from an individual or mutual fund company and also because during such period too much money chases a few shares. The stock exchanges provide a meeting point for the buyers and sellers to negotiate and determine the fair price of a stock.

Aids Industries to Raise Capital: If a company performs better, then it may find many investors. Shares of such good performing companies are actively traded in the market. This facilitates the company to command good price for the subsequent primary issue in the market. This creates a cyclical process in the market. If a company issues shares in the market and raises funds, then the performance of the company in later years will determine the issue price of the subsequent offerings. The premium demanded by the company reflects its past performance. Thus, the stock exchange acts as a channel which opens up avenues for the companies to raise further capital.

Other Allied Functions: A stock exchange ensures transparency in the process of trading in securities, thereby creating confidence among the investors. A higher degree of transparency helps in eliminating unfair trade practices from the market.


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