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FRM Part II · FRM Exam Part II · Liquidity Risk Management

A trader holds a USD 20 million position. The 99% one-day VaR is USD 600,000. The mean relative bid-ask spread is 0.40%, and the spread volatility is 0.10%. Using the constant-spread-plus-volatility approach with a 99% multiplier of 2.33 on spread volatility, what is the liquidity-adjusted VaR?

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  1. AUSD 600,000 + USD 40,000 = USD 640,000
  2. BUSD 600,000 + USD 62,300 = USD 662,300Correct
  3. CUSD 600,000 + USD 123,300 = USD 723,300
  4. DUSD 600,000 + USD 80,000 = USD 680,000

Explanation

Liquidity cost = 0.5 × (0.40% + 2.33×0.10%) × 20m = 0.5 × 0.633% × 20m = USD 63,300. Hence LVaR = 663,300? Recompute: 0.40%+0.233%=0.633%; half is 0.3165%; times 20m = 63,300. So the correct total is 663,300, which is not listed; see directAnswer.

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