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FRM Part II · FRM Exam Part II · Liquidity and Leverage

A risk manager adds a liquidity adjustment to a 99% one-day VaR. The asset's relative spread has mean 0.40% and standard deviation 0.10%, and the 99% spread multiplier is 3. The position is 10 million. Using the approach of adding half the spread (mean plus 3 standard deviations) as a cost, what is the liquidity cost?

The liquidity cost is 35,000. The stressed relative spread is 0.40% plus three times 0.10%, which is 0.70%; half of this is 0.35%, applied to the 10 million position.

  1. A35,000Correct
  2. B70,000
  3. C14,000
  4. D20,000

Explanation

Mean plus 3 SD = 0.40% + 0.30% = 0.70%. Half = 0.35%. Times 10 million = 35,000. Using the full spread gives 70,000 (distractor); using only the mean gives 20,000.

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