Question 1

Lender-of-last-resort LOLR moral hazard is:&#10;A)the problem that the bank will keep too little liquidity because it knows the LOLR will provide it.&#10;B)the problem that the LOLR may not provide the bank access to liquidity when needed.&#10;C)the problem that the bank's financiers will not give it access to liquidity because they know the LOLR will provide it.

Accepted Answer

Lender-of-last-resort moral hazard refers to the risk that banks may take on excessive risks or hold insufficient liquidity because they know that the LOLR will step in to provide liquidity in times of financial distress. This creates a moral hazard problem because banks may not take sufficient precautions to manage risk, knowing that the LOLR is available as a safety net. Option B refers to a crisis in which the lender-of-last-resort does not provide liquidity, while option C refers to a different issue of funding availability from the bank's financiers.

Question 2

Lender-of-last-resort LOLR) moral hazard is:&#10;A)the problem that the bank will keep too little liquidity because it knows the LOLR will provide it.&#10;B)the problem that the LOLR may not provide the bank access to liquidity when needed.&#10;C)the problem that the bank's financiers will not give it access to liquidity because they know the LOLR will provide it.

Accepted Answer

Lender-of-last-resort moral hazard refers to the risk that banks may take on too much risk because they know that the lender-of-last-resort will be there to rescue them in case of a liquidity crisis. In other words, the presence of a lender-of-last-resort can create a moral hazard problem where banks keep too little liquidity because they know the lender-of-last-resort will provide it when needed. This is why the lender-of-last-resort must balance the need for providing liquidity with the need to avoid creating moral hazard. Choice B and C do not accurately describe LOLR moral hazard.

Question 3

Liquidity risk is related to default risk because ________________________.

Accepted Answer

If a sudden need for liquidity forces you to sell illiquid assets quickly, the value realized may be so low that it can impair solvency, so liquidity risk can trigger default risk.Also, unexpectedly high defaults can raise concerns about insolvency, causing funding to dry up.So default risk can create liquidity risk.

Question 4

The central elements) of liquidity risk isare)&#10;A)the speed at which deposits can be raised&#10;B)the speed at which an asset can be sold&#10;C)the asset sold should not lose much of its value at the time of conversion&#10;D)the asset can be sold at any price&#10;E)both b and c

Accepted Answer

Both option B and C are central elements of liquidity risk. The speed at which an asset can be sold is important because, in times of crisis or when there is a need for cash, the bank must be able to quickly convert assets into cash. However, it is also important that the asset does not lose much of its value at the time of conversion because this can result in losses to the bank. Therefore both elements are important to manage liquidity risk. Option A is not necessarily a central element but can be a factor to consider depending on the specific situation. Option D is not a desirable element because the bank may be forced to sell an asset at a loss if it cannot find a buyer at a reasonable price.

Question 5

Liquidity risk is defined as ________________________________________.

Accepted Answer

The answer of Liquidity risk is defined as ________________________________________....

Question 6

Liquidity risk can be reduced by ___________________________________.

Accepted Answer

The answer of Liquidity risk can be reduced by ___________________________________....

Question 7

Liquidity risk is related to interest rate risk because ____________________.

Accepted Answer

The answer of Liquidity risk is related to interest rate...

Deck 6: Liquidity Risk