Liquidity cost

[itsyourz]

hi,

simple quick question

why is liquidity cost low when the asset is fungible

could you explain it ?

if the asset that i want to liquidate is fungible, the buyer of this asset can choose another asset which is a substitution of mine
therefore, isn't it hard to liquidate? then it costs more, doesn't it?

i think im wrong, but i can not understand in the opposite way

suk

 

[David Harper CFA FRM]

Hi suk,

What Culp says is, fungibility is a question of: how easy is it to "unwind" the position by either sale or offset.
In his definition, lack of fungibility is when you need to negotiate/sell with the counterparty; i.e., you have no options to unwind.

Culp: "non fungible assets that must be unwound rather than offset or sold are subject to potential bilateral monopoly bargaining problems." So, bilateral monopoly bargaining problems means, in so many words, you've got to sell/close with the counterparty (you have no fungible replacements) and that is leverage for the counterparty.

A good example, IMO, of fungibility is the cheapest to deliver (CTD) bond that can be delivered in a Treasury Bond futures contract. The whole point of that system (i.e., to allow the short to select among several bonds) is to introduce fungibility - and makes it less costly, from a liquidity standpoint, for the short to close out the position

(good luck tomorrow!)

David