Reading 62: Risks Associated with Investing in Bonds-LOS k 习 2011, statements, following, important

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Session 15: Fixed Income: Basic Concepts
Reading 62: Risks Associated with Investing in Bonds

LOS k: Explain liquidity risk and why it might be important to investors even if they expect to hold a security to the maturity date.

 

 

Which of the following statements about liquidity risk is least accurate?

A) A lack of liquidity may make it difficult to determine the value of a security.

B) The bid-ask spread is an indication of the liquidity of a security.

C) Liquidity risk and the bid-ask spread are not relevant to an investor who is planning to hold a security to maturity.

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Even if the investor plans to hold the security until maturity rather than trade it, poor liquidity can have adverse consequences stemming from the need to periodically mark securities to market. When a security has little liquidity, the variation in dealers’ bid prices (or a lack of bids) makes valuation more difficult. Bid-ask spreads tend to be narrower for more liquid securities and wider for less liquid securities.

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Which of the following statements does NOT describe a characteristic of an illiquid asset or market?

A) Large block trades that do not materially affect prices.

B) Small trading volumes.

C) Wide bid-ask spreads.

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In a liquid market with large trading volumes, large block trades should not affect prices. The other choices are characteristics of illiquid markets or assets.

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Which of the following statements regarding liquidity risk is NOT correct?

A) Emerging markets typically have more liquidity risk than established markets.

B) Liquidity risk is not important to an investor who intends to hold a security until maturity.

C) The bid-ask spread is one measurement of liquidity risk.

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Even if an investor intends to hold securities to maturity, liquidity risk impacts portfolios when marking to market and through changes in investor tastes and preferences over time. For example, liquidity is important to institutional investors that must determine market values for net asset values (NAVs) and to dealers in the repurchase market for collateral valuation.

A narrow bid-ask spread indicates a liquid asset, while a wide bid-ask spread indicates an illiquid asset. For example, the spreads on recently issued Treasury securities are often only a few basis points. Emerging markets are usually less liquid than established markets, one reason being the small trading volumes.

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Which of the following investors is least likely to have liquidity risk concerns? A:

A) corporate bond investor who intends to hold securities until maturity.

B) financial institution heavily involved in the repurchase market.

C) trader who invests exclusively in Treasury bonds.

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Treasury securities are the most liquid of the investments mentioned.

The repurchase market is short term in nature and the collateral is marked-to-market daily. Thus, the need to quickly convert securities to cash (and at approximately market value) is very important. Emerging markets are usually less liquid than established markets, one reason being the small trading volumes. Even if an investor intends to hold the security to maturity, liquidity risk impacts portfolios when marking to market and through changes in investor tastes and preferences over time. For example, liquidity is important to institutional investors that must determine market values for net asset values (NAVs).

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Which of the following assets is the least liquid?

A) Foreign exchange futures contract.

B) On-the-run Treasury security.

C) Limited Partnership.

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All other choices are considered highly liquid assets. On-the-run Treasuries are recently issued and are often more liquid than older issues.