FRM Part II · FRM Exam Part II · Liquidity Risk
A desk head observes that during a stress episode the quoted bid-ask spread on a bond stays unchanged, yet the desk can only sell small lots at the quoted bid and larger sales move the price materially lower. Which statement best describes the liquidity dimension that the quoted spread fails to capture?
The quoted spread misses market depth. It applies only to small quoted sizes, so larger sales push prices down further than the spread suggests. This is endogenous liquidity cost, which depends on the size of the trade, and a spread-only adjustment understates it.
- AImmediacy risk, because the quoted spread measures how fast a trade can be settled
- BMarket depth, because the quoted spread applies only to a limited trade sizeCorrect
- CResiliency, because the quoted spread reflects how quickly prices recover after a trade
- DTightness, because the quoted spread overstates the cost of trading small lots
Explanation
Quoted spreads are valid only up to a quoted size. When larger trades walk down the book, the shortfall reflects limited depth (endogenous liquidity). Tightness is what the quoted spread measures, and resiliency concerns price recovery, not size-related impact.
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