Explanation:
Let's analyze each option:
Option A is incorrect: A liquidity backstop is actually a source of emergency funding, not a halt in funding. It's typically provided by parent banks or central banks to support entities like SIVs during liquidity crises.
Option B is correct: A narrowing of the bid-ask spread indicates improved market liquidity. When spreads narrow, it's easier to buy and sell assets without significant price impact, which is a key characteristic of liquid markets.
Option C is incorrect: Both loss spirals and margin spirals can generate significant losses, but they operate differently. A loss spiral occurs when declining asset values trigger forced sales, which further depress prices. There's no inherent comparison that one generates "lower new position value" than the other.
Option D is incorrect: In a CDS, the protection buyer makes periodic payments to the protection seller. The protection buyer receives payments only if a credit event occurs, not regular cash flows from the underlying portfolio.
The correct answer is B, as it accurately describes the relationship between bid-ask spreads and market liquidity.
Ultimate access to all questions.
A
A liquidity backstop is a temporary halt in funding liquidity to structured investment vehicles (SIVs) in order to minimize credit losses.
B
A narrowing of the bid-ask spread results in an increase in market liquidity.
C
Because of the forced sale of assets due to declining asset values, a loss spiral generates a lower new position value than a margin spiral.
D
The credit protection buyer in a credit default swap (CDS) receives cash flows from the portfolio that underlies the CDS.
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