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Answer: If market liquidity decreases, the liquidity horizon will lengthen, and the credit risk exposure will increase.
The correct answer is B. If market liquidity decreases, the liquidity horizon—the time it takes to liquidate a position—will increase. This is because, in a less liquid market, it becomes more difficult to quickly sell assets without significantly affecting their prices. As a result, the bank may be forced to hold onto its assets for a longer period, which increases the duration of its credit risk exposure. The longer the bank has to hold a position, the more time there is for the credit risk to manifest, such as through changes in the borrower's financial situation or broader economic conditions. Consequently, the bank's credit risk exposure will typically increase due to the extended time frame it is exposed to these risks.
Author: LeetQuiz Editorial Team
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In the context of a quantitative risk analyst incorporating market liquidity into a bank's Value at Risk (VaR) model, which statement best describes the likely impact of market liquidity fluctuations on the liquidity horizon and the bank's credit risk exposure?
A
If market liquidity decreases, the liquidity horizon will shorten, and the credit risk exposure will increase.
B
If market liquidity decreases, the liquidity horizon will lengthen, and the credit risk exposure will increase.
C
If market liquidity increases, the liquidity horizon will shorten, and the credit risk exposure will increase.
D
If market liquidity increases, the liquidity horizon will lengthen, and the credit risk exposure will decrease.
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