Chapter 12 - Liquidity Risk
Solutions for End-of-Chapter Questions and Problems: Chapter Twelve
1. How does the degree of liquidity liquidity risk risk differ differ for different different types types of financial financial institutio institutions? ns? Due to the nature of their asset and liability contracts depository institutions are the !"s #ost e$posed to liquidity risk. risk. %utual funds hedge funds pension funds and &C insurance co#panies are the least e$posed. "n the #iddle are life insurance co#panies. 2. 'hat are the the two reasons reasons liquidity liquidity risk risk arises? arises? How does liquidity liquidity risk risk arising arising fro# the liability side of the balance sheet differ fro# liquidity risk arising fro# the asset side of the balance sheet? 'hat is #eant by fire(sale prices? prices? Liquidity risk occurs because of situations that de)elop fro# econo #ic and financial transactions that are reflected on either the asset side of the balance sheet or the liability side of the balance sheet of an !". *sset side risk arises fro# transactions that result in a transfer of cash to so#e other asset such as the e$ercise of a loan co##it#ent or a line of credit. Liability side liquidity risk arises fro# transactions whereby a creditor depositor or other clai# holder de#ands cash in e$change for the clai#. +he withdrawal of funds fro# a bank is an e$a#ple of such a transaction. *nother type of asset side liquidity risk arises a rises fro# the !",s in)est#ent portfolio. During a sell(off liquidity dries up and in)est#ent securities can be sold only at fire(sale prices. * fire(sale fire(sale price refers to the price of an asset that is less than the nor#al #arket price because of the need or desire to sell the asset i##ediately under conditions of financial distress. -. 'hat are are core deposits deposits?? 'hat role role do core deposit depositss play in predicti predicting ng the probabili probability ty distribution of net deposit drains? Core deposits are those deposits that will stay with the D" o)er an e$tended period of ti#e. +hese deposits are relati)ely stable sources of funds and consist #ainly of de#and sa)ings and retail ti#e deposits. ecause of their stability a higher le)el of core deposits will increase the predictability of forecasting net deposit drains fro# the the D". /. +he probabilit probability y distribut distribution ion of the net net deposit deposit drains drains of a D" has been esti#ate esti#ated d to ha)e a #ean of 2 percent and a standard de)iation of 1 percent. "s this D" increasing or decreasing in si0e? $plain. +his D" is decreasing in si0e because less core deposits are being added to the D" than are being withdrawn. n a)erage the rate of o f decrease of deposits is 2 percent. "f the distribution is nor#al we can state with 34 percent confidence that the rate of decrease dec rease of deposits will be between 5 percent and / percent 6i.e. plus or #inus two standard de)iations7.
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Chapter 12 - Liquidity Risk
4.
How is the D";s distribution pattern of net deposit drains affected by the following? a. +he holiday season.
+he entire distribution shifts to the right 6an increase in the e$pec ted a#ount of withdrawals7 as indi)iduals spend #ore. %oreo)er the standard de)iation decreases as the distribution narrows.
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Chapter 12 - Liquidity Risk
6a7
*ssigning a tea# that will take charge in the e)ent of a liquidity crisis.
6b7
"dentifying the account holders that will #ost likely withdraw funds in the e)ent of a crisis.
6c7
sti#ating the si0e of the run(offs and the sources of borrowing to ste# the run(offs.
6d7
stablishing #a$i#u# li#its for borrowing by subsidiaries and affiliates including inter( affiliate loans and the #a$i#u# risk pre#iu# to be paid during crisis borrowing.
6e7
5 15 155 5
$iabilities and E%uit# .55 A155 $ 5.55 5.55 A124 $ 5.54 =.24 A155 $ 5.15 15.55 A/45 $ 5.>4 -->.45 A-==./4
+otal cash inflows o)er ne$t -5 days +otal net cash outflows o)er ne$t -5 days
>.45
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Liquidity co)erage ratio A-/-#
[email protected]# 34.4=G. +he bank is not in co#pliance with liquidity require#ents based on the LCR. 13.
'alls!arther ank has the following balance sheet 6in #illions of dollars7.
Liquidity le)el Assets Cash A 12 Le)el 1 Deposits at the !ed 13 Le)el 1 +reasury securities 124 Le)el 1 9:%* securities 3/ Le)el 2* Loans to ** rated corporations 1-@ Le)el 2* Loans to rated corporations 1 5= Le)el 2 &re#ises 25 +otal A41/
$iabilities and E%uit# .25 Le)el 2 assets A15= $ 5.@4 A35.15 Cash outflowsB 5# 131.=@G. +he bank is in co#pliance with liquidity require#ents based on the :5 @5 155 5
$iabilities and E%uit# /.45# Required a#ount of stable funding A25 $ 5.55 E 6A-5 E A1/47 $ 5.54 E A=5 $ 5.25 E 6A4/5 E A2@47 $ 5.=4 E A-4 $ 1.55 A432.55# :et stable funding ratio A>>/.45#A432.55# 1-5.@-G. +he bank is in co#pliance with liquidity require#ents based on the :./2# if sold in four days. b. "n a crisis if depositors all de#and pay#ent on the first day what a#ount will they recei)e? 'hat will they recei)e if they de#and to be paid within the week? *ssu#e no deposit insurance. "f depositors de#and to withdraw all their #oney on the first day the D" will ha)e to dispose of its loans at fire(sale prices of A/4.5- #illion. 'ith its A2 #illion in cash it will be able to pay depositors on a first(co#e basis until A/>.5- #illion has been withdrawn. +he rest will ha)e to wait until liquidation to share the re#aining proceeds. -@4
"15(day
6A3#A1-5#76A3#A3#7 E 6A1=#A1-5#76A14.4#A1=#7 E 6A15#A1-5#76A3#A15#7 E 6A34#A1-5#76A>4#A34#7 5.@-/=
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