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P2.T7.511. Transaction liquidity risk and liquidity-adjusted VaR (Malz)

Nicole Seaman

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Learning outcomes: Identify the main sources of transactions liquidity risk. Calculate the expected transactions cost and the 99 percent spread risk factor for a transaction. Calculate the liquidity-adjusted VaR for a position to be liquidated over a number of trading days.

Questions:

511.1. Each of the following is a source (i.e., cause) of transactions liquidity risk EXCEPT which is not?

a. Inventory management by dealers
b. Adverse selection
c. Depth of resiliency
d. Differences of opinion


511.2. The bid-ask spread is USD 0.350 on an asset with a current price of USD 50.00 per share. The spread itself is normally distributed with mean of zero and volatility of 20 basis points (0.20%). Which is nearest to the 99 percent confidence interval on the transaction costs?

a. $0.08510
b. $0.29130
c. $1.05560
d. $3.82400


511.3. Let's define liquidity-adjusted value at risk (VaR) for a position that can be liquidated over (T) days as given by:




Let's assume an equity position with a value of one million dollars ($1,000,000) and a volatility of 34.0% per annum. If there are 250 trading days in a year and returns are normal i.i.d., which is nearest to the 99.0% liquidity-adjusted VaR if we estimate the position will require five (5) trading days to liquidate?

a. $50,000
b. $74,200
c. $98,900
d. $111,840

Answers here:
 
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