P2.T8.20.1. Liquidity trading cost (Hull Ch.24)

[Nicole Seaman]

Learning objective: Explain and calculate liquidity trading risk via cost of liquidation and liquidity-adjusted VaR (LVaR).

Questions:

20.1.1. An asset that is not very liquid is quoted bid $89.00, offer $96.00. Which is nearest to the proportional bid-offer spread?

a. 0.0378
b. 0.0757
c. 0.1538
d. 7.000


20.1.2. An investor holds two positions:

• Short shares worth $10,000 where the proportional bid-offer spread is 0.030, and
• Long shares worth $17,000 where the proportional bid-offer spread is 0.040

What is the approximate cost to the investor to unwind this two-position portfolio?

a. $490.00
b. $750.00
c. $980.00
d. $1,300.00


20.1.3. An investor holds two positions:

• Long shares worth $25,000 where the bid-offer spread has a mean and standard deviation of 0.050
• Long shares worth $40,000 where the bid-offer spread has a mean and standard deviation of 0.030

If we assume the bid-offer spreads are normally distributed, then which is nearest to the worst expected cost of unwinding with 95.0% confidence?

a. $1,730
b. $2,950
c. $3,240
d. $6,500

Answers here:

• In forum