FRM Part II · FRM Exam Part II · Liquidity Risk Management
A trader holds a position in a bond quoted at bid 98.40 and ask 98.60. The mid price is used for marking. Assuming the position of USD 20 million face value would be liquidated at the bid, with no price impact beyond the spread, what is the approximate liquidity cost relative to mid-price valuation?
The liquidity cost is USD 20,000. Mid is 98.50 and the bid is 98.40, so selling at the bid gives up 0.10 per 100 of face value, or 0.10%. Applied to USD 20 million that equals USD 20,000, which is half the quoted spread.
- AUSD 20,000
- BUSD 40,000Correct
- CUSD 200,000
- DUSD 400,000
Explanation
Mid = 98.50. Selling at the bid costs 0.10 points, i.e. half the spread (0.20/2). On USD 20 million face, 0.10% = USD 20,000... check: 0.10 per 100 = 0.10%, so cost = 20,000,000 x 0.001 = USD 20,000. Hence the correct choice is the half-spread cost.
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