Academy - Report of Life Liquidity Flashcards
1
Q
What is liquidity risk
A
The risk that at some time an entity will not have enough cash or liquid asset to meet its cash obligations.
2
Q
Possible sources of liquidity Risk
A
- A credit rating downgrade, which results in either more demands for collateral from lenders, or an early withdrawl of funds from customers/policyhoders.
- Negative publicity: which causes customers to lose confidence in the company and make early withdrawls.
- Deterioration of the economy
- Reports of problems at similar companies, raising fears that such problems exist at the company.
3
Q
Three levels of liquidity management
A
- day-to-day cash management
- intermediate term cash flow management
typical strategy for 1&2 will be to conserve cash and access credit lines
3.stress liquidity risk management:
response for 3 will typically involve forced liquidation of assets
4
Q
Examples of company-specific characteristics that can contribute to liquidity risk exposure include:
A
- A single or a few contract holders control large sums of money.
- The sized of the company may limit access to capital markets.
- too small => may not have the funding choices available to large companies
- if large company is forced to liquidate billions of $s of assets at once, the marketplace may not be able to absorb the volume without a discount from fair value
- Immediate demands on cash
- Any immediate demand for a cash payment can be a risk if cash is in short supply
- A predictable cash demand is less of a risk. A well-managed company can structure its assets to cover the known obligation.
- Unpredictable deferred or deferrable demands on cash.
- Insufficient ability to borrow short-term through bank line of credit, commercial paper, etc.
- Lack of diversity in either the liability or the asset portfolio
5
Q
Liquidity sources that are common
A
- Asset Sales (of the most liquid assets, size of haircut should be eveluated)
- Asset Securitizations (to monetize future cash flows without selling the assets in the open market, consider cost of securitization)
- Borrowing (preferably at pre-agreed terms on an existing credit facility)
- Increase Premiums Written
6
Q
Haircut
A
Haircut: the difference between the fair value and the estimated amount of cash that can be raised by a sale
7
Q
Risk Reduction Techniques
A
- Cash flow match: ladder asset maturities to closely match liability maturities
- Diversify assets: less susceptible to a stress situation
- Diversify liability: diversification by market, product, channel, etc
- Ladder liability maturities not forced to flood market with new sales
- Back Surplus/capital with liquid assets: available for extreme events. But there is a price tag involved
- Establish a durable line of credit
- Issue commercial paper: can used to access short-term markets under normal operation
- Use repurchase agreements: use repos to mitigate ST cash needs. Disadvantage is that repos typically tie up assets that are relatively liquid, so it is usually not a viable long-term solution
- Purchase liquidity options