Financial Risk Manager Part 1
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In finance, liquidity is a critical concept that pertains to the ease with which an asset can be converted into cash without affecting its market price. Two key types of liquidity that are often discussed in this context are funding liquidity and market liquidity. These terms, while related, refer to different aspects of financial liquidity:
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A
Funding liquidity describes the ease with which expert investors can obtain funding from financiers by using purchased assets as collateral, whereas market liquidity describes the ease with which investors can raise money by selling their assets.
B
Funding liquidity refers to the total value of an investor's assets that can be quickly converted into cash, while market liquidity refers to the overall ability of the market to absorb the sale of large assets without significant price fluctuations.
Explanation:
Explanation
Correct Answer: A
Funding Liquidity vs Market Liquidity:
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Funding Liquidity refers to the ability of an institution or investor to obtain funding (borrow money) to meet its financial obligations. This typically involves using assets as collateral to secure loans from financiers.
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Market Liquidity refers to the ability to quickly buy or sell assets in the market without causing significant price changes. It describes how easily investors can convert assets into cash through market transactions.
Why Option A is correct:
- It accurately describes funding liquidity as obtaining funding using assets as collateral
- It correctly defines market liquidity as raising money by selling assets
- This aligns with standard financial definitions where funding liquidity relates to borrowing capacity, while market liquidity relates to trading capacity
Why Option B is incorrect:
- It confuses the concepts by defining funding liquidity as asset conversion to cash (which is actually market liquidity)
- It misrepresents market liquidity by focusing only on large asset sales
- The definitions are reversed and incomplete
Key Distinction:
- Funding Liquidity: About borrowing/obtaining funds
- Market Liquidity: About buying/selling assets in markets
Both are crucial in risk management as funding liquidity crises can trigger market liquidity crises and vice versa, creating systemic risks.
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