Liquidity Risk

A liquidity discount represents a reduction in the value or price of an asset because it is less liquid.

Investors may demand a higher return from bonds that combine greater credit risk with lower liquidity.

The liquidity gap is calculated as liquid assets minus volatile liabilities.

A negative liquidity gap means liquid assets are less than volatile liabilities and may indicate difficulty meeting obligations without additional funding.

Liquidity Risk Elasticity measures how sensitive a firm‘s net assets over liabilities are to changes in funding costs.

Liquidity risk is the risk of being unable to meet financial obligations or trade assets quickly without a significant loss.

Market liquidity risk occurs when an asset cannot be quickly converted into cash because of insufficient buyers or market demand.

Funding liquidity risk occurs when an entity does not have enough liquid assets or cash flow to meet its financial obligations.

A wider bid-ask spread makes trading more costly and can make it harder to transact without accepting an unfavorable price.

Low trading volume can make it difficult to find buyers or sellers for an asset.

During periods of uncertainty, investors may become less willing to trade, reducing market liquidity.

A maturity mismatch occurs when liabilities fall due before the assets generating cash can be converted into funds.

A bank run occurs when many depositors withdraw funds at the same time, creating severe funding liquidity pressure.

Excessive borrowing increases repayment and interest obligations, which can become difficult to meet when income falls or costs rise.

A downgrade can reduce access to funding and may increase funding costs or trigger demands for repayment.

Maintaining cash and highly liquid assets provides resources for meeting unexpected cash needs.

Credit lines provide access to additional funding when an organization faces a temporary cash shortfall.

Cash flow management helps ensure that incoming funds are sufficient and appropriately timed to meet outgoing payments.

The crisis showed how financial institutions could face severe funding and market liquidity pressures when credit markets became impaired.

Loss of depositor confidence contributed to withdrawals and liquidity pressure, leading to regulatory intervention.

A counterparty default can reduce expected cash inflows and leave an institution unable to meet its own obligations.

A hedge may protect against price movements, but the instruments may still be difficult to sell or fund when cash is urgently needed.

Stress testing evaluates whether an organization can withstand severe scenarios such as large withdrawals or major defaults.

Scenario analysis considers how liquidity would change under different possible market and economic conditions.

Using multiple funding sources reduces dependence on a single provider or market.

A contingency plan establishes actions and funding arrangements to be used during a liquidity crisis.

The Liquidity Coverage Ratio (LCR) is a Basel III liquidity standard designed to strengthen banks‘ short-term liquidity resilience.

Investors generally demand additional expected return as compensation for bearing greater liquidity risk.

L-CAPM extends the traditional CAPM by incorporating liquidity-related risk into expected return considerations.

A Lookback Option determines its payoff using the highest or lowest price of the underlying asset over a specified period.