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

A trader holds a position in a bond quoted at a bid of 99.40 and an ask of 99.60. Using the quoted bid-ask spread as the measure of market liquidity, which statement best describes the cost of immediately buying and then selling one unit of this bond, assuming quotes do not change?

The round trip costs 0.20 per 100 face value, the full quoted spread, because the trader buys at the ask of 99.60 and sells at the bid of 99.40. Half the spread, 0.10, is only the one-way cost relative to the mid price.

  1. AThe round-trip cost equals 0.20 per 100 face value, or about 0.20%, being the full quoted spreadCorrect
  2. BThe round-trip cost equals 0.10 per 100 face value, being half the quoted spread
  3. CThe round-trip cost equals 0.40 per 100 face value, being twice the quoted spread
  4. DThe round-trip cost is zero because the bond is bought and sold at the same mid price

Explanation

Buying at the ask (99.60) and selling at the bid (99.40) loses 0.20 per 100, the full spread. Half the spread (0.10) is the cost of a one-way trade relative to mid, not a round trip. Trading at mid is not possible for a liquidity demander.

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