Explanation:
Balance sheet risk, also known as funding liquidity risk, is the risk that creditors either withdraw credit or change the terms on which it is granted in such a way that the positions have to be unwound and/or are no longer profitable. This risk can arise due to perceived or actual deterioration in the borrower’s credit quality, or due to overall deteriorating financial conditions. In the case of Nathan Capital, the lender is increasing the collateral requirements, thus changing the terms of credit. This is happening despite Nathan Capital being financially sound and showing no signs of financial deterioration. Therefore, this situation represents a balance sheet risk for Nathan Capital.
Choice A is incorrect. Transaction liquidity risk refers to the risk that a firm may not be able to execute a transaction at the prevailing market price because of the size of the transaction relative to normal market size. In this case, Nathan Capital is not facing any issues with executing transactions at prevailing market prices, but rather it's experiencing an increase in collateral requirements.
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Q.2277 Nathan James, a trader for Nathan Capital, works on the short-term funding desk at his firm. Over the past few months, markets have been highly volatile but Nathan Capital still enjoys a large capital base and is financially stable. In his monthly report to the liquidity subcommittee of the board of directors, James reports that in the last month, Nathan Capital's chief lender has been steadily increasing collateral requirements to roll over repo contracts. From the perspective of Nathan Capital, this represents:
A
Transactions liquidity risk
B
Balance sheet risk
C
Systematic risk
D
Maturity transformation risk