Question

Give an example of a situation in which it would be appropriate to apply a liquidity discount, and explain why it is appropriate.

Answer 1

Asset liquidity is the key in financial market. Liquidity the ease through which the asset can be converted into cash. Investors always high liquidity and would pay extra for the asset that is liquid compared to an asset that would be illiquid.

A shareholder will have more liquidity in public held company as compared to privately held company. For example, if an investor wishes to sell their share in a public traded company, if he is not satisfied with the returns the management, it is easily possible as there will be instant virtual liquidity so that he is compensated. But in private company, without the ready market an investor won’t have the accessibility to gain or avoid losses . therefore the interest rates in private company are inclusive of the liquidity risk and thus value of private is considered at liquidity discount, as compared to investment in public complies.