Answer: Yield spread between on-the-run and off-the-run securities mainly captures the liquidity premium, and not the market and credit risk premium.

## Explanation Let's analyze each option: **Option A**: Incorrect. Asset liquidity risk refers to the risk that an institution cannot easily liquidate its assets without significant price discounts, not the inability to meet payment obligations. The inability to meet payment obligations is actually funding liquidity risk. **Option B**: Incorrect. During a "flight to quality," investors move from riskier assets (like corporate bonds) to safer assets (like government bonds). This typically causes the yield spread between corporate and government issues to INCREASE, not decrease, as investors demand higher compensation for holding riskier corporate bonds. **Option C**: Correct. The yield spread between on-the-run (most recently issued) and off-the-run (previously issued) securities of the same issuer primarily reflects liquidity differences. On-the-run securities are more liquid and trade at lower yields, while off-the-run securities are less liquid and trade at higher yields. This spread mainly captures the liquidity premium rather than market or credit risk premiums, since both securities have the same credit quality and market risk characteristics. **Option D**: Incorrect. Setting limits on certain asset markets or products and diversification are strategies to manage ASSET liquidity risk, not funding liquidity risk. Funding liquidity risk is typically managed through maintaining adequate cash reserves, establishing credit lines, and managing liability structures. Therefore, only statement C is correct regarding liquidity risk.

Author: LeetQuiz .