Module: | MODULE B: RISK MANAGEMENT
Q367: A treasury market maker quotes a specific corporate bond with a bid price of ₹ 99.25 and an ask price of ₹ 100.00 (based on a ₹ 100 face value).
Calculate the absolute bid-ask spread in basis points (where 1 basis point equals ₹ 0.01) and determine what this spread width generally indicates regarding the bond's market liquidity.
✅ Correct Answer: B
The correct answer is B. The Bid-Ask Spread is calculated by subtracting the Bid Price from the Ask Price.
Here, Ask Price = ₹ 100.00 and Bid Price = ₹ 99.25.
Spread = 100.00 - 99.25 = ₹ 0.75.
Since 1 basis point equals ₹ 0.01, ₹ 0.75 equals 75 basis points.
In fixed-income markets, the bid-ask spread is the primary indicator of Market Liquidity Risk.
A tight spread (e.g., 2 to 5 basis points for government securities) indicates high liquidity and market depth.
A wide spread of 75 basis points for a standard bond indicates a relatively illiquid market with higher execution risk, meaning the bank will have to accept a significant discount to sell the asset quickly.
Option A is incorrect in its interpretation of the market condition.
Here, Ask Price = ₹ 100.00 and Bid Price = ₹ 99.25.
Spread = 100.00 - 99.25 = ₹ 0.75.
Since 1 basis point equals ₹ 0.01, ₹ 0.75 equals 75 basis points.
In fixed-income markets, the bid-ask spread is the primary indicator of Market Liquidity Risk.
A tight spread (e.g., 2 to 5 basis points for government securities) indicates high liquidity and market depth.
A wide spread of 75 basis points for a standard bond indicates a relatively illiquid market with higher execution risk, meaning the bank will have to accept a significant discount to sell the asset quickly.
Option A is incorrect in its interpretation of the market condition.