Liquidity and Treasury Risk Measurement and Management

Question 1

The proportional bid–offer spread

Answer 1

Question 2

Cost of liquidation

Answer 2

• α is the dollar (mid-market) value of the position
• s is the proportional bid–offer spread
• n is the number of positions

Question 3

Cost of liquidation (stressed market)

Answer 3

* α is the dollar (mid-market) value of the position

• Define u_i and σ_i as the mean and standard deviation of the proportional bid–offer spread for the ith financial instrument held
• The parameter λ gives the required confidence level for the spread

Question 4

The liquidity coverage ratio (LCR)

Answer 4

Question 5

The net stable funding ratio (NSFR)

Answer 5

Question 6

The leverage ratio

Answer 6

Question 7

The leverage effect

Answer 7

• r^e = equity return
• r^{<span>d</span>}​ = cost of debt
• L = leverage

Question 8

Tax equivalent yield (TEY)

Answer 8

Question 9

Net after-tax return on municipals

Answer 9

Question 10

Tax advantage of a qualified bond

Answer 10

Question 11

Financial firms net liquidity position

Answer 11

Question 12

The interest cost for both Fed funds and repurchase agreements

Answer 12

Question 13

Certificate of deposit interest rate

Answer 13

Question 14

Available funds gap (AFG)

Answer 14

Question 15

Effective cost rate on deposit and nondeposit sources of funds

Answer 15

Question 16

The average cost approach to LTP (Liquidity Transfer Pricing) two major defects

Answer 16

• It neglects the varying maturity of assets and liabilities by applying a single charge for the use and benefit of funds
• It lags changes in banks’ actual market cost of funding

Question 17

Funds Transfer Price (FTP)

Answer 17

• Base rate = rate depicted from the swap curve corresponding to the asset’s contractual/ behavioural maturity or repricing term, whichever is less
• Term liquidity premium = spread between the swap curve and the bank’s marginal cost of funds curve based on the contractual/ behavioural maturity of the asset
• Liquidity premium = cost of carrying liquidity cushion averaged over total assets of the bank

Question 18

Bank discount rate

Answer 18

Question 19

Convert the bank discount rate to the yield-to-maturity

Answer 19

Question 20

Net interest margin (NIM)

Answer 20

Question 21

Interest-sensitive gap (IS gap)

Answer 21

Question 22

Relative IS Gap ratio

Answer 22

Question 23

Interest Sensitivity Ratio (ISR)

Answer 23

• Interest sentsitive assets (ISA)
• Interest sensitive liabilities (ISL)

Question 24

Net interest income

Answer 24

Question 25

Duration formula

Answer 25

Question 26

Price change relation do duration

Answer 26

Question 27

Leveraged adjusted duration gap

Answer 27

Question 28

Three key biases cause people to overstate expected returns and understate the risk of illiquid assets

Answer 28

* Survivorship bias * Infrequent sampling * Selection bias

Question 29

There are four ways an asset owner can capture illiquidity premiums

Answer 29

* By setting a passive allocation to illiquid asset classes, like real estate * By choosing securities within an asset class that are more illiquid, that is by engaging in liquidity security selection * By acting as a market maker at the individual security level * By engaging in dynamic strategies at the aggregate portfolio level

Question 30

Repo haircut

Answer 30

Haircuts are the repo market's way of imposing a margin on the collateral seller. Here is a simple example. Suppose a haircut of 2% is applied to a repo trade where the market value of the collateral is $10m. The seller only receives $9.8m from the buyer and the repo interest is calculated on $9.8m.

Question 31

Repo cash flows

Answer 31

* Cash inflow = Notional \* (current bond price% + coupon rate \* time since last coupon) \* (1 - haircut) * Cash outflow = Cash inflow \* (1 + repo interest)

Question 32

Reverse REPO

Answer 32

A reverse repo is a short-term agreement to purchase securities in order to sell them back at a slightly higher price.

Question 33

Sell the REPO

Answer 33

* When financing a purchase of securities, financial institutions often sell the repo to avoid putting up full purchase price for the securities. * Selling the repo is the same as entering into a repo agreement, where the security is sold and bought back later.

Question 34

Capacity ratio

Answer 34

= net loans and leases / total assets

Question 35

Real-life liquidity risk failures

Answer 35

* Northern Rock in 2007 - Negative public perception of emergency borrowing from the central bank can cause a bank run. * LTCM in 1998 - Positive feedback trading in illiquid instruments can cause excessive losses. * Metallgesellschaft in 1993 - Hedging liabilities by rolling forward futures contracts may create cash flow mismatches.