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

A trading desk holds a large position in a thinly traded corporate bond. The risk manager notes that the desk could only exit the position quickly by accepting a price well below the current mid-quote. Which type of liquidity risk does this primarily describe?

This is market liquidity risk, because the firm can only sell its large position quickly by accepting a price well below mid. Market liquidity risk concerns price impact when trading assets, whereas funding liquidity risk concerns the ability to meet cash and collateral obligations.

  1. AMarket liquidity riskCorrect
  2. BFunding liquidity risk
  3. CSettlement risk
  4. DModel risk

Explanation

Market liquidity risk is the risk that a position cannot be unwound quickly without a material adverse price impact. The scenario is about exit price versus mid-quote, not about meeting cash obligations. Funding liquidity risk concerns the ability to meet payment and collateral obligations.

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