Liquidity risk, Financial Management

An investor, who wants to sell a bond even before it reaches its maturity date, would be concerned as to whether he will receive a price that is close to the true value of the issue. True value is indicated by a recent transaction. For example, let us consider that an investor wants to sell bond X; of late, the issue has been trading between Rs.100 and Rs.101. (A selling price between Rs.100 and Rs.101 is considered as the true value of the issue). The investor would expect to sell the bond somewhere between these prices. If the market conditions change, there is always a risk that the investor will not be able to sell at this price. The risk that the investor will have to sell a bond below its true value is referred to as liquidity risk. Liquidity can be measured as the size of the spread between the bid price and the ask price. A narrow bid-ask spread results in a lower liquidity risk while a wider bid-ask spread results in a greater liquidity risk.

Posted Date: 9/10/2012 1:24:42 AM | Location : United States







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