FRM Part II · FRM Exam Part II · Liquidity Risk Management
A risk manager adjusts a 1-day 99% VaR for liquidity by adding a cost based on the bid-ask spread. The position is worth USD 50 million, the quoted relative bid-ask spread is 0.60%, and the position can be liquidated at the quoted spread. Using the standard constant-spread liquidity adjustment (half the spread times position value), what is the liquidity cost to add to VaR?
The liquidity cost is USD 150,000. Liquidating at the bid rather than the mid price costs half the relative spread, so 0.5 × 0.60% × USD 50 million equals USD 150,000. Using the full spread would double-count the cost.
- AUSD 150,000Correct
- BUSD 300,000
- CUSD 600,000
- DUSD 75,000
Explanation
Liquidity cost = 0.5 × spread × position value = 0.5 × 0.006 × 50,000,000 = USD 150,000. Using the full spread (USD 300,000) overstates the cost because a liquidation crosses only half the spread relative to the mid price.
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