Define liquidity risk and name two metrics used to assess liquidity.

Define liquidity risk and name two metrics used to assess liquidity.

• A. Liquidity risk is the risk of not meeting cash obligations; metrics include cash-on-hand and liquidity coverage ratio.
• B. Liquidity risk is the risk of loan defaults; metrics include net worth ratio and loan-to-share ratio.
• C. Liquidity risk is the risk of interest rate changes; metrics include duration and convexity.
• D. Liquidity risk is the risk of not meeting cash obligations; metrics include cash-on-hand and deposit growth rate.

Answer: (A)

Liquidity risk is the risk that an institution cannot meet its financial obligations as they come due because it lacks enough cash or liquid assets. The best answer uses cash-on-hand to reflect available immediate cash, and the liquidity coverage ratio to gauge readiness for short-term stress by comparing high-quality liquid assets to expected net cash outflows over a 30-day horizon. Together, these two metrics cover both the immediate cash position and the ability to endure a sudden liquidity squeeze. The other options mix in concepts that aren’t about liquidity. Defining liquidity risk as loan defaults points to credit risk rather than liquidity. Linking it to interest rate changes brings in interest rate risk, with duration and convexity as measures of price sensitivity, not liquidity. Using deposit growth rate as a liquidity measure doesn’t directly quantify how well obligations can be met in the near term.

Liquidity risk is the risk that an institution cannot meet its financial obligations as they come due because it lacks enough cash or liquid assets. The best answer uses cash-on-hand to reflect available immediate cash, and the liquidity coverage ratio to gauge readiness for short-term stress by comparing high-quality liquid assets to expected net cash outflows over a 30-day horizon. Together, these two metrics cover both the immediate cash position and the ability to endure a sudden liquidity squeeze.

The other options mix in concepts that aren’t about liquidity. Defining liquidity risk as loan defaults points to credit risk rather than liquidity. Linking it to interest rate changes brings in interest rate risk, with duration and convexity as measures of price sensitivity, not liquidity. Using deposit growth rate as a liquidity measure doesn’t directly quantify how well obligations can be met in the near term.