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FRM Part II · FRM Exam Part II · Liquidity Risk Management

A fund must sell a large block of stock and is choosing between selling immediately and spreading sales over several days. Which statement best describes the trade-off in an optimal liquidation framework?

Selling faster increases market-impact cost because larger trades move the price against the seller, but it reduces the time the position is exposed to price volatility. Selling slowly does the reverse. Optimal liquidation balances expected impact cost against the risk of holding.

  1. AFaster selling lowers market-impact cost but raises price risk from holding the position
  2. BFaster selling raises market-impact cost but lowers price risk from holding the positionCorrect
  3. CSlower selling lowers both market-impact cost and price risk
  4. DSlower selling raises both market-impact cost and price risk

Explanation

Rapid liquidation pushes prices against the seller, so impact cost rises, but the exposure to adverse price moves is shortened. Slower liquidation reduces impact but leaves the position exposed to market risk longer. Optimal liquidation balances these two.

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