Lecture 9: Liquidity risk

Question 1

Solvency and liquidity are synonyms
TRUE/ FALSE

Answer 1

FALSE

A solvent financial institution can fail because of liquidity problems

Question 2

_____ refers to a company having more assets than liabilities
A) Liquidity
B) Solvency

Answer 2

(B) Solvency refers to a company having more assets than liabilities

Question 3

_____ refers to the ability of a company to make cash payments as they become due
A) Liquidity
B) Solvency

Answer 3

(A) Liquidity refers to the ability of a company to make cash payments as they become due

Question 4

What are the two types of liquidity risk?
A) Liquidity funding risk
B) Liquidity credit risk
C) Liquidity solvency risk
D) Liquidity trading risk

Answer 4

A) Liquidity funding risk
D) Liquidity trading risk

Question 5

There are two types of liquidity risk: liquidity trading and liquidity funding risk.

The (in)ability to turn financial assets into cash without (too much) impact on the price of the asset is referred to as _____

Answer 5

The (in)ability to turn financial assets into cash without (too much) impact on the price of the asset is referred to as LIQUIDITY TRADING RISK

Question 6

There are two types of liquidity risk: liquidity trading and liquidity funding risk.

The (in)ability to meet cash needs (from liabilities) as they arise is referred to as _____

Answer 6

The (in)ability to meet cash needs (from liabilities) as they arise is referred to as LIQUIDITY FUNDING RISK

Question 7

Liquidity trading risk refers to the (in)ability to turn financial assets into cash without (too much) impact on the price of the asset. The price of an asset depends on what? Select all correct
A) The mid-market price (midpoint price between bid and ask prices
B) The quantity to be sold
C) The urgency of the sale
D) The credit rating of the seller
E) The economic environment
F) The credit rating of the buyer

Answer 7

A) The mid-market price (midpoint price between bid and ask prices
B) The quantity to be sold
C) The urgency of the sale
E) The economic environment

Question 8

In the theoretical case of no friction, the fair asset price is determined as the midpoint price between the bid and ask prices. This price is referred to as____?

Answer 8

Mid-market price: the midpoint price between the bid and ask prices

Question 9

One of the determinants for asset price is the quantity to be sold. If quantities traded are significant, the spread between the bid and the ask increases. I.e., the seller may need to be willing to accept a (HIGHER/LOWER) price for the sale.

Answer 9

One of the determinants for asset price is the quantity to be sold. If quantities traded are significant, the spread between the bid and the ask increases. I.e., the seller may need to be willing to accept a LOWER price for the sale.

Question 10

The economic environment affect asset prices. In turbulent markets, the spread between bid and ask will (INCREASE/ DECREASE)

Answer 10

The economic environment affect asset prices. In turbulent markets, the spread between bid and ask will INCREASE

Question 11

The main measure of market liquidity of an asset is _______

Answer 11

Its bid-offer spread

Question 12

The cost of liquidation is higher when holding a short position than when holding a long position.
TRUE/FALSE

Answer 12

FALSE

The cost of liquidation is EQUIVALENT in the event of short and long position. This cost exists regardless of position due to the fact that the market is NOT FRICTIONLESS, and the asset therefore CANNOT be traded at the mid-market price.

Question 13

Basel III introduced the Liquidity Coverage Ratio (LCR). This ratio is calculated as bank’s the high quality liquid assets divided by the net cash outflows in a 30-day period.
It is required that LCR must be equal to or higher than ____
A) 100%
B) 90%
C) 70%

Answer 13

It is required that LCR must be equal to or higher than (A) 100%
Note: this implies that the bank has liquid assets sufficient to survive the acute stress pressures

Question 14

Basel III introduced the Net Stable Funding Ratio (NSFR). This ratio is calculated as bank’s amount of stable funding divided by the required amount of stable funding, which incorporate a available stable funding (ASF) factor and required stable funding (RSF) factor respectively

It is required that NSFR must be equal to or higher than ____
A) 100%
B) 90%
C) 70%

Answer 14

It is required that NSFR must be equal to or higher than (A) 100%

Question 15

When calculating the Net Stable Funding Ratio (NSFR), the higher the available stable funding (ASF) factor, the HIGHER the stability of the funding source.
Rank the following categories from most to least stable:
A) Stable demand deposits (e.g., time deposits +1y maturity)
B) Tier 1 + Tier 2 capital
C) Less stable demand deposits (e.g., time deposits <1y maturity)
D) Wholesale demand deposits (e.g., time deposits <1y maturity)

Answer 15

1) Tier 1 + Tier 2 capital
2) Stable demand deposits (e.g., time deposits +1y maturity)
3) Less stable demand deposits (e.g., time deposits <1y maturity)
4) Wholesale demand deposits (e.g., time deposits <1y maturity)

Question 16

When calculating the Net Stable Funding Ratio (NSFR), the higher the required stable funding (RSF) factor, the HIGHER the requirement for stable funding for the given asset.

Does cash have a high RSF factor?

Answer 16

NO - the RSF factor assigned to cash is 0%. This is the most liquid type of assets that one can hold, and does not require any stable funding.