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CHAPTER 15 LIQUIDITY RISK Chapter outline Causes of Liquidity Risk Liquidity Risk at Banks and Other Depository Institutions Liability-Side Liquidity Risk Asset-Side Liquidity Risk Purchased Liquidity Management Stored Liquidity Management Measuring a Depository Institution’s Liquidity Exposure Sources and Uses of Liquidity Peer Group Ratio Comparisons Liquidity Index Financing Gap and the Financing Requirement The BIS Approach: Maturity Ladder/Scenario Analysis Liquidity Planning Immediate Liquidity Obligations Seasonal Short-term Liquidity Trend Liquidity Needs Cyclical Liquidity Needs Contingent Liquidity Needs Liquidity Risk, Unexpected Deposit Drains, and Bank Runs Deposit Drains and Bank Runs Liquidity Risk Bank Runs, the Discount Window and Deposit Insurance Financial System Stability and Liquidity Reserve Bank Role in Maintaining Financial System Stability Financial Institution Instability: The Australian Experience Financial Institutions’ Losses in the 1990s Financial Institutions’ Losses in the 2000s ADI Liquidity Regulations Liquidity Regulations — Historic Perspective Liquidity Risk and Life Insurance Companies Instructor’s Resource Manual t/a Financial Institutions Management 1
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Liquidity Risk and General Insurers Managed Funds The Supply of Shares of an Open-end Managed Fund Instructor’s Resource Manual t/a Financial Institutions Management 2
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Answers to end-of-chapter questions QUESTIONS AND PROBLEMS 1. How does the degree of liquidity risk differ for different types of financial institutions? Depository institutions are the FIs most exposed to liquidity risk. Managed funds, pension funds, superannuation funds and property-casualty insurance companies are the least exposed. In the middle are life insurance companies. 2. What are the two reasons why liquidity risk arises? How does liquidity risk arising from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance sheet? What is meant by fire-sale prices? Liquidity risk occurs because of situations that develop from economic and financial transactions that are reflected on either the asset side of the balance sheet or the liability side of the balance sheet of an FI. Asset-side risk arises from transactions that result in a transfer of cash to some other asset, such as the exercise of a loan commitment or a line of credit. Liability-side risk arises from transactions whereby a creditor, depositor, or other claim holder demands cash in exchange for the claim. The withdrawal of funds from a bank is an example of such a transaction. A fire-sale price refers to the price of an asset that is less than the normal market price because of the need or desire to sell the asset immediately under conditions of financial distress 3. What are core deposits? What role do core deposits play in predicting the probability distribution of
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