CFA Level I · CFA Level I Exam · Equity Issuance and Trading
In a quote-driven market, a dealer's bid–ask spread is most likely to widen when:
The spread most likely widens when the dealer faces greater inventory risk from price volatility. Dealers need compensation for holding positions that may move against them. More liquidity, higher volume and dealer competition tend to narrow spreads.
- Atrading volume rises and competition among dealers increases
- Bthe dealer faces greater inventory risk from price volatilityCorrect
- Cthe security becomes more liquid and easily traded
Explanation
Dealers are compensated for inventory risk and adverse selection, so higher volatility widens spreads. Greater liquidity, higher volume and more competition narrow spreads.
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