Iliquid versus insolvent

Here is an example to explain illiquidity versus insolvency.

You have an asset that has cash flows of 0.5 today and 1.0 in one year.

Ignore interest rates.  The asset is worth 0.5 + 1.0=1.5

You are illiquid if you have a loan with a payment of 1.10 today–you only have 0.5 cash to pay off your loan, so you need to get an extra 0.6.  If you can get a new loan,  then borrow 0.6  in a new loan.

Your position is
today: 0.5 + 0.6 new loan – loan payment of 1.10 = 0
one year 1.0-0.6 loan repayment = 0.4

Your net value today is 0+0.4 = 0.4

You are illiquid, but solvent if you cannot find anyone to lend you the money.

Now suppose that your loan is 2.00 today.  Your assets are only worth 1.5,so your nett value is 1.5 in assets  minus  2.00 in original loans  or -0.5 so no one will lend you any new money to pay back the original loan.  You are insolvent because your assets are worth less than your liablities.

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