Risk mgmt 1

CFA Level I Portfolio Management
#1

Liquidity risk is most associated with:

  1. the probability of default.
  2. a widening bid–ask spread.
  3. a poorly functioning market.

probability of default leads to Default Risk
Widening bid-ask spread risk leads to Liquidity Risk.
Poory functioning market leads to which risk
help

#2

Greetings friend - the width of the bid-ask spread is related to liquidity. In the simplest way I think about it:

If a stock is very liquid (trades at high daily volume), the bid-ask spread should be rather narrow (meaning that what lots people are willing to offer for a stock is close to what lots of people are willing to pay, so the stock trades easily and the bid-ask spread is narrow).

If a stock is less liquid, one reason can be that what lots of people are willing to sell the stock for is too far away from what lots of people are ready to buy it for. So the bid-ask spread is wide and as a result the stock trades less. There is less of a “meeting of the minds” in the market for buying/selling the stock and therefore daily trading volumes are lower.

So as the bid-ask spread widens, this “meeting of the minds” decreases, less people are trading and as a result liquidity decreases (lower daily trading volume).

Cheers - good luck - you got this :+1:

#3

Thank you I got then answer for liquidity risk.
I m asking poor economic conditions leads to which kind of risk.
Gratitude

#4

Poor economic conditions can be called “economic risk” sometimes, and it’s part of “systematic risk” also known as market risk. Sounds like maybe they mean market risk here.

1 Like
#5

Allow me to chip in:

A poorly functioning market is a vague term and could mean a variety of things. There is no definite one answer to this. But if You asked me I believe a poorly functioning market would exhibit the following :slight_smile:

  1. An underdeveloped and inefficient market where information asymmetry is widespread

  2. A market where the civil, legal and political rights are either ill defined or are heavily lopsided in favour of a particular class of beneficiaries. Potential Asset misappropriation could render any investment worthless

  3. The divide between the rich and the poor is stark and ever widening. Limited capital market participation of the population

  4. Market functionaries are ill defined and a far cry from technological advances

  5. A closed market that is either slow to adapt to prescription improvement or is unwilling to

  6. A country whose economic and monetary policies are poorly conceived or is clear anti development thereby depriving the country of club convergence

  7. A market whose capital markets and mainstream economic activities are either divergent or are remotely reflective of one another

Pick up your choice

1 Like