FRM Part II · FRM Exam Part II · Liquidity Risk
A fund holds EUR 50 million of a security. 99% one-day VaR is EUR 1.5 million. The mean spread is 0.50% and the spread volatility is 0.20%. Using the constant-spread-plus-stochastic approach with the 99% spread estimated as mean plus 2.33 standard deviations, what is the liquidity cost, calculated as half the spread times position value?
The 99% spread is 0.50% plus 2.33 times 0.20%, which is 0.966%. Half of that, 0.483%, applied to EUR 50 million gives a liquidity cost of EUR 0.2415 million. Using only the mean spread would understate the cost.
- AEUR 0.125 million
- BEUR 0.233 million
- CEUR 0.2400 million
- DEUR 0.2415 millionCorrect
Explanation
Worst-case spread = 0.50% + 2.33 x 0.20% = 0.966%. Half is 0.483%. Times 50m = EUR 0.2415m. Using the mean spread only gives 0.125m, which ignores spread volatility.
Did you get it right without looking?
One question tells you little. A timed set on Liquidity Risk shows your real accuracy, how long you take and where you lose marks.
More Liquidity Risk questions
- During a contingency funding plan (CFP) review, the board notes that early warning indicators have breached their thresholds, but no escalat…
- Which of the following is a recognised limitation of the constant-spread LVaR approach that adds half the spread times position value to VaR…
- During the 2007-2009 crisis, which feature of the funding structure of many dealer banks and conduits most directly made them vulnerable to …
- During a crisis, a dealer bank holds a position it financed overnight in the repo market. The position is worth 100 and the repo haircut ris…
- Under the LCR, a bank computes net cash outflows over 30 days. Total expected cash outflows are USD 500 million and total expected cash infl…
- Which mechanism best explains a liquidity spiral in which falling asset prices and tightening funding reinforce each other?