5. Liquidity risk Which of the following are sources of liquidity risk? Check al
ID: 1158685 • Letter: 5
Question
5. Liquidity risk Which of the following are sources of liquidity risk? Check all that apply. An increase in the amount of interest rate-sensitive liabilities An unexpected decrease in withdrawals by depositors An unexpected increase in withdrawals by depositors An unexpected increase in loans due to prior loan commitments Which of the following are potential solutions to the liquidity problem? Check all that apply Borrowing from the Federal Reserve Raising cash by selling Treasury bills and commercial paper Raising cash by issuing commercial paper Extending more loansExplanation / Answer
ans: a.
Liquidity risk is the risk that a company or bank may be unable to meet short term financial demands i.e. the inability to convert a security or hard asset to cash without a loss of capital and/or income in the process.
the sources of liquidity risk are:
1. an unexpected increase in withdrawals by depositers as bank might not have sufficient cash if every deposier starts withdrawing leading to liquidity crisis.
2. an unexpected increase in loans due to prior loan commitments as if everyody start taking another loan for paying off the previous loan the bank may ran into liquidity crisis.
3. an increase in amount of interest rate sensitive liabilities as rise in liability also poses a liquidity risk.
ans b.
the problem can be solved by:
1. borrowing from federal reserve as FED is the lender of last resort for all commercial banks.
2. raising cash by sellling treasury bills and commercial paper as banks hold securities however they cannot issue commercial paper as that is done by big companies and not banks .
option 4 is also ruled out as extending more loans means more cash outflow which wlll not solve our liquidity problem rather it will increase the poblem further.
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