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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

A trading desk holds a large position in a thinly traded corporate bond. Its model values the bond at a mid-price, but the desk estimates that selling the full position quickly would require accepting a price well below mid because of a wide bid-ask spread and limited market depth. Which risk is most directly illustrated?

The scenario shows market liquidity risk: the position cannot be sold quickly at the mid-price because wide bid-ask spreads and thin market depth force a price concession. Funding liquidity risk would instead involve difficulty raising cash to meet obligations, which the scenario does not describe.

  1. AFunding liquidity risk
  2. BMarket liquidity riskCorrect
  3. CSettlement risk
  4. DModel risk only

Explanation

Market liquidity risk is the risk that a position cannot be unwound quickly without an adverse price impact, reflected in wide spreads and shallow depth. Funding liquidity risk concerns meeting cash obligations, which is not described here. Settlement risk concerns failed delivery or payment.

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