Module: | MODULE B: RISK MANAGEMENT
Q366: Consider the following statements contrasting Market Liquidity Risk and Funding Liquidity Risk in banking operations:
1. Market Liquidity Risk arises when a bank is unable to quickly sell or liquidate a specific asset without accepting a massive discount to its current market price.
2. Funding Liquidity Risk represents the inability of the bank to meet its short-term cash obligations, margin calls, or deposit withdrawals efficiently.
3. A significant widening of the bid-ask spread for a particular corporate bond in the secondary market is a primary indicator of escalating Funding Liquidity Risk.
2. Funding Liquidity Risk represents the inability of the bank to meet its short-term cash obligations, margin calls, or deposit withdrawals efficiently.
3. A significant widening of the bid-ask spread for a particular corporate bond in the secondary market is a primary indicator of escalating Funding Liquidity Risk.
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: Market Liquidity Risk is an asset-specific problem.
It occurs when the market depth for a specific security dries up, and the bank must take a "fire-sale" discount to liquidate it.
Statement 2 is correct: Funding Liquidity Risk is an institution-wide problem.
It is the liability side of the equation, occurring when a bank cannot raise the necessary cash to meet its immediate obligations, leading to potential insolvency.
Statement 3 is incorrect: The widening of the bid-ask spread is the classic, textbook indicator of Market Liquidity Risk, not Funding Liquidity Risk.
A wide spread means market makers are demanding a massive premium to execute trades due to a lack of buyers and sellers for that specific bond.
It occurs when the market depth for a specific security dries up, and the bank must take a "fire-sale" discount to liquidate it.
Statement 2 is correct: Funding Liquidity Risk is an institution-wide problem.
It is the liability side of the equation, occurring when a bank cannot raise the necessary cash to meet its immediate obligations, leading to potential insolvency.
Statement 3 is incorrect: The widening of the bid-ask spread is the classic, textbook indicator of Market Liquidity Risk, not Funding Liquidity Risk.
A wide spread means market makers are demanding a massive premium to execute trades due to a lack of buyers and sellers for that specific bond.