FRM Part II · FRM Exam Part II · Liquidity Risk
A trader holds a position with a mid-price of USD 50 per share and 100,000 shares. The current quoted bid-ask spread is USD 0.40 per share. Using the constant-spread approach to liquidity-adjusted VaR, which liquidity cost is added to the normal VaR?
The liquidity cost is USD 20,000. Under the constant-spread approach, the cost equals half the relative spread times position value: 0.5 x 0.8% x USD 5 million. Liquidating at the bid rather than the mid-price costs only half the spread per share.
- AUSD 10,000
- BUSD 20,000Correct
- CUSD 40,000
- DUSD 2,000
Explanation
Constant-spread liquidity cost = 0.5 x position value x relative spread. Position value = 5,000,000 and relative spread = 0.40/50 = 0.8%. Cost = 0.5 x 5,000,000 x 0.008 = USD 20,000. USD 40,000 is wrong because it uses the full spread rather than half the spread.
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