Liquidity Risk .

8/6/2019 Liquidity Risk .

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Liquidity risk Micu Anca

Year III,BA



1.Theory

W hat is liquidity risk?

W hat happens during liquidity crisis?

2.Case study

3Conclusions Will it happen again?

How do we solve the crisis and reduce the risk of future ones?

Purpose and Objectives



Understand the liquidity term,see w hat are

the liquidity sources that affects banks Understand how can we fix the problem of

liquidity in the case of a company

Discuss th

e posibility of liquidity events tohappen again.

Objectives



There are two kinds of liquidity:

Market liquidity : A security has a good market liquidity if it is ³easy´ to trade,that could be asmall price impact,easy search(OTC markets).

Market liquidity risk =the risk that the market liquidity worsens w hen you needto trade.

Funding liquidity :

A bank or a investor has a good funding liquidity if it has enough availablefunding from its own capital or from loans.

Funding liquidity risk =a trader cannot fund his position and is forced to give up.

Definition



[Dry climate]

Liquidity Shortage Assassin of banks



Excess Liquidity A drag on competition[Flood]



[ Analysis and Diagnosis of causes ]



Deterioration of the economy OR

Reports of problems of other companies breakdown in payments

Negative publicity ( w hether justfied or not) but

Incorrect judgment or attitude of the bank Risk activation by secondary sources:

-business strategy failure

-corporate governance failure

Liquidity risk sources-Banks



A company has outgoings of $8,000,000 a month against incomefrom sales of $10,000,000. It faces a number of threats to itsliquidity: for example, the price of the commodity it sells has fallen by 25%, leaving its income at $7,500,000 against $8,000,000

outgoings, and it has to find a way to raise the additional$500,000.

Some major customers have cut their orders, leaving the company with a surplus of products to sell on the market. It has lost$4,000,000 in ³normal´ monthly sales and now has to offloadproducts it is forced to sell, below cost, at 50% of the expected price

simply to pay its bills ($6,000,000 in expected sales plus$2,000,000 to meet monthly obligations of $8,000,000).

Give some examples of how the company couldchose to secure its position and iron out liquidity problems?

Case Study



Set up a loan with its bank to help cover the shortfall

Make new interesting offerts for companies(example you buy 100 items you will receive 50 items free)

Find new customers to sell some assets but the risk isthat in hurry they will not receive the book price

Minimize cost of capital,allowing atend the market at

competitive prices during tough

times Organizing lines of credit well in advance w hich is the

cheapest option because activities of a company andthe market it operates in are dynamic.There will beperiods w hen it is cash-rich and others w hen it iscash-poor.This strategy is known as ³life insurance´ of the company .

Solutions



W hat is needed?

W hat can be done?

Conclusion



In general(for world,avoiding crises): Development of liquidity measurement instruments

Development of infrastructure institutions

Particulary (companies):

Examine predicted cash flows for the company .Look for any major negatives and the impact of the imbalanced market.

Start a process of scenario testing. W hat happens if there isno demand for our products?

Ensure that the impacts of rare events are tested too.The

more there are,statistically the higher the probability thatone will occur.

Finally,ensure that inflows and outflows match as far aspossible.



Yes,almost surely in some markets

Certain trades often get crowded over time

Sudden losses can lead to simultaneous unwind andliquidity risk situations

Liquidity crisis is part of the equilibrium:

If there was no risk of crisis,traders will have an incentive

to lever up moreCrisis are(somew hat) rare:

Banks try to stay liquid and traders actively try to stay away from margin constraint

Most likely to occur in iliquidity markets in w hich levered

specialized traders play a large role

Will Liquidity E vents Happen

Again?



Thank you!

Liquidity Risk .

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