FRM二级基础段培训课件：流动性风险（标准版）

FRM二级培训讲义-基础班LiquidityandTreasuryRiskMeasurement

andManagementTopicWeightingsinFRMPart

IISession

NO.Contents%Session1MarketRiskMeasurementand

Management20Session2CreditRiskMeasurementand

Management20Session3OperationalRiskand

Resiliency203-319Session

4LiquidityandTreasuryRiskMeasurementandManagement15Session

5Risk

Management

and

Investment

Management 15Session

6CurrentIssuesinFinancial

Market10Framework[Ch1]Liquidity

Risk[Ch2]Liquidityand

Leverage[Ch14]RepurchaseAgreementsandFinancing[Ch8]TheFailureMechanicsofDealerBanks4-319Part1:IdentifyandMeasureLiquidityLiquidity

Risk5-319Chapter

1Chapter24ofRiskManagementandFinancialInstitutions,5thEdition,byJohnC.

Hull.FrameworkLiquidityTrading

RiskLiquidityFunding

RiskLiquidityBlack

Holes6-3191.LiquidityTrading

Risk7-319LiquidityTradingRisk:Riskofmovingthepriceofanassetadverselyintheactofbuyingorsellingit.Transactionliquidityriskislowifassetscanbeliquidatedorapositioncanbecoveredquickly,cheaply,andwithoutmovingthepricetoomuch.Anassetisliquidifitis“near”oragoodsubstitutefor

cash.Anassetissaidtohavealiquiditypremium

ifitspriceislowerandexpectedreturnhigherbecauseitisn’tperfectly

liquid.Amarket

issaidtobeliquidifmarketparticipantscanputonorunwindpositionsquickly,withoutexcessivetransactionscostsandwithoutexcessiveprice

deterioration.1.LiquidityTrading

Risk8-319Thepriceatwhichaparticularassetcanbesolddepends

onThemid-marketpriceoftheasset,oranestimateofits

valueHowmuchoftheassetistobe

soldHowquicklyitistobesoldTheeconomic

environment1.LiquidityTrading

Risk9-319Bid-OfferSpreadasaMeasureof

LiquidityHigherOFFERPrice:priceatwhichatrader

sells.LowerBIDPrice:priceatwhichtrader

buys.Thedifferencebetweenthebidandaskpricesisacostofliquidity.Thebid-offerspreadis

exogenousIfourpositionissmall,relativetothesizeofthemarket,thenourtradingshouldhaveanegligibleimpactonthemarket

price.Thebid-offerspreadistosomeextent

endogenousIfourpositionislargerelativetothemarket,ouractivitiescanaffectboththemarketpriceandthebid-ask

spread.Forexample,ifwesuddenlyunloadalargeposition,weshouldexpectthe‘market’pricetofallandthebid-offerspreadtowiden.1.LiquidityTrading

RiskBid-offer

spreadp=offerprice-bid

prices=mid−market

priceofferprice−

bid

price offerprice−bid

price=offerprice+bidprice

⁄2costofliquidation=�

𝑠𝑠𝑖𝑖

𝑎𝑎𝑖𝑖2Costofliquidation(Normal

market)𝑛𝑛10-319𝑖𝑖=1Where:𝑠𝑠𝑖𝑖

=spreadfori-th

instrument𝑎𝑎𝑖𝑖

=dollarvalueofthei-thinstrument

position1.LiquidityTrading

Riskcostofliquidation

=

� 𝜇𝜇𝑖𝑖

+

𝛼𝛼𝜎𝜎𝑖𝑖

𝑎𝑎𝑖𝑖2Costofliquidation(Stressed

market)𝑛𝑛11-319𝑖𝑖=1Where:𝜇𝜇𝑖𝑖

=meanof

𝑠𝑠𝑖𝑖𝜎𝜎𝑖𝑖

=standarddeviationof

𝑠𝑠𝑖𝑖𝛼𝛼

=confidence

parameterExampleExample1:Supposethatafinancialinstitutionhasbought10millionsharesofonecompanyand50millionouncesofacommodity.Thesharesarebid$89.5,offer$90.5.Thecommodityisbid$15,offer$15.1.Themid-marketvalueofthepositioninthesharesis90x10=$900million.Themid-marketvalueofthepositioninthecommodityis15.05x50=$752.50

million.Theproportionalbid-offerspreadforthesharesis1/90or

0.01111.Theproportionalbid-offerspreadforthecommodityis0.1/15.05or

0.006645.Thecostofliquidationinanormalmarket

is900×

0.01111/2

+752.5×

0.006645/2

=7.5

or

$7.5million.12-319ExampleExample2:SupposethatinExample

1themeanandstandarddeviationforthebid-offerspreadforthesharesare$1.0and$2.0,

respectively.themeanandstandarddeviationforthebid-offerspreadforthecommodityareboth

$0.1.themeanandstandarddeviationfortheproportionalbid-offerspreadforthesharesare0.01111and0.02222,

respectively.Themeanandstandarddeviationfortheproportionalbid-offerspreadforthecommodityareboth

0.006645.Assumingthespreadsarenormallydistributed,thecostof

liquidationthatweare99%confidentwillnotbeexceeded

is0.5

×

900

×

(0.01111

+

2.326

×

0.02222)

+

0.5

×

752.5

×

(0.006645

+2.326×

0.006645)=36.58or$36.58million.13-3191.LiquidityTrading

RiskorLVaR=VaR+�

𝑠𝑠𝑖𝑖

𝑎𝑎𝑖𝑖2Liquidity-adjusted

VaR𝑛𝑛𝑖𝑖=1LVaR=VaR

+

� 𝜇𝜇𝑖𝑖

+

𝛼𝛼𝜎𝜎𝑖𝑖

𝑎𝑎𝑖𝑖2𝑛𝑛14-319𝑖𝑖=1ExerciseYou

are

holding

100

SkyTrek

Company

shares

with

a

current

price

of$30.Thedailymeanandvolatilityofthestockreturnare2%and3%,respectively.VARshouldbemeasuredrelativetoinitialwealth.Thebid-askspreadofthestockvariesovertime,andthedailymeanandvolatilityofthisspreadare0.5%and1%,reactively.Thereturnisnormallydistributed.Whatisthedailyliquidity-adjustedVAR(LVAR)ata99%confidencelevelassumingtheconfidenceparameterofthespreadisequalto

2.58?A. $193.15B. $172.62C. $103.50D. $195.90CorrectAnswer:

D15-3192.Liquidityfunding

Risk16-319LiquidityFunding

RiskThisisthefinancialinstitution'sabilitytomeetitscashneedsastheyarise.Liquidityfundingproblemsatafinancialinstitutioncanbecaused

by:Liquiditystressesinthe

economy.Overlyaggressivefunding

decisions.Apoorfinancialperformance,leadingtoalackof

confidence.Thekeytomanagingfundingliquidityriskispredictingcashneedsandensuringthattheycanbemetinadverse

scenarios.2.Liquidityfunding

Risk17-319Themainsourcesofliquidityforafinancialinstitution

are:HoldingsofcashandTreasury

securitiesTheabilitytoliquidatetradingbook

positionsTheabilitytoborrowmoneyatshort

noticeTheabilitytoofferfavorabletermstoattractretailandwholesaledepositsatshort

noticeTheabilitytosecuritizeassets(suchasloans)atshort

noticeBorrowingsfromthecentral

bank2.Liquidityfunding

Risk18-319CaseStudy:Northern

RockAnexcessiveuseofshort-termfinancingforlong-termassetsandasuddenlossofmarketconfidence

triggeredafundingliquidity

crisis.NorthernRockacceptedemergencygovernmentsupportandthenpublic

ownership.TheNorthernRockstoryillustratesjusthowquicklyliquidityproblemscanleadtoabankspiralingdownward.Ifthebankhadbeenmanagedalittlemoreconservativelyandhadpaidmoreattentiontoensuringthatithadaccesstofunding,itmighthavesurvived.2.Liquidityfunding

Risk19-319CaseStudy:Ashanti

GoldfieldsAshantiGoldfields,aWestAfricangold-miningcompanybasedinGhana,experiencedproblemsresultingfromitshedgingprogram

in1999.Ithadsoughttoprotectitsshareholdersfromgoldpricedeclinesbysellinggoldforward.OnSeptember26,1999,15Europeancentralbankssurprisedthemarketwithanannouncementthattheywouldlimittheirgoldsalesoverthefollowingfive

years.Thepriceofgoldjumpedupover

25%.Ashantiwasunabletomeetmargincallsandthisresultedinamajorrestructuring,whichincludedthesaleofamine,adilutionoftheinterestofitsequityshareholders,andarestructuringofitshedge

positions.2.Liquidityfunding

Risk20-319CaseStudy:

METALLGESELLSCHAFTIntheearly1990s,Metallgesellschaft(MG)soldahugevolumeof5-to10-yearheatingoilandgasolinefixed-pricesupplycontractstoitscustomers.Ithedgeditsexposurewithlongpositionsinshort-datedfuturescontractsthatwererolled

forward.Asitturnedout,thepriceofoilfellandthereweremargincallsonthefuturespositionswithconsiderableshort-termcashflowpressures.ThemembersofMGwhodevisedthehedgingstrategyarguedthattheseshort-termcashoutflowswereoffsetbypositivecashflowsthatwouldultimatelyberealizedonthelong-termfixed-price

contracts.However,thecompany’sseniormanagementanditsbankersbecameconcernedaboutthehugecash

drain.Asaresult,thecompanyclosedoutallthehedgepositionsandagreedwithitscustomersthatthefixed-pricecontractswouldbeabandoned.TheoutcomewasalosstoMGof$1.33

billion.2.Liquidityfunding

RiskLiquidityCoverage

RatioTheratioofthestockofhigh-qualityliquidassetstothenetcashoutflowsover30daysmustbegreaterthan100%.Itallowthebanktoconvertassetsintocashtomeetliquidityneedsunderastress

scenario.LCR

=High−QualityLiquidAssetsNetCashoutflowsin30−day

period≥

100%21-319ExerciseGiventhefollowinginformation,whatisBankA’sliquiditycoverageratio?22-319$100$200$130$90$210High-qualityliquid

assetsRequiredamountofstable

fundingCashoutflowsoverthenext30

daysNetcashoutflowsoverthenext30

daysAvailableamountofstable

fundingHigh-qualityliquidassetsineachmajorcurrency$75A.

83%B.

90%C.

111%D.

130%CorrectAnswer:

C2.Liquidityfunding

RiskNetStableFundingRatio

(NSFR)NSFRfocusesonliquiditymanagementoveraperiodofoneyear

i.e.long-termfinancialresourcesmustexceedlong-term

commitments.Stablefundingbroadlycomprises

of:Equityandanyliabilitymaturingafterone

year.Retaildeposits&depositsfromnon-financialcorporatesandpublicentities.Forthenumerator,dependingonthetypeoffundingsource,each

categoryoffundingismultipliesbyanavailablestablefunding(ASF)factor,reflectingtheir

stability.For the denominator, each category of these is multiplied by arequiredstablefunding(RSF)

factor.NSFR

=AmountofStable

FundingRequiredAmountofStable

Funding≥

100%23-3192.Liquidityfunding

Risk24-319ASFFactorsforNetStableFunding

RatioASF

FACTORCATEGORY100%Tier1andTier2

capital90%“Stable”demanddepositsandtermdepositswithremainingmaturitylessthanoneyearprovidedbyretailorsmallbusinesscustomers.80%“LessStable”demanddepositsandtermdepositswithremainingmaturitylessthanoneyearprovidedbyretailorsmallbusiness

customers.50%Wholesaledemanddepositsandtermdepositswithremainingmaturitylessthanoneyearprovidedbynonfinancialcorporates,sovereigns,centralbanks,multilateraldevelopmentbanks,andpublicsector

entities.0%Allotherliabilityandequity

categories2.Liquidityfunding

Risk25-319RSFFactorsforNetStableFunding

RatioRSF

FACTORCATEGORY0%Cash5%Marketablesecuritieswitharesidualmaturitygreaterthanoneyeariftheyareclaimsonsovereigngovernmentsorsimilarbodieswitha0%risk

weight.20%CorporatebondswitharatingofAA-orhigheranda

residualmaturitygreaterthanone

year.Claimsonsovereigngovernmentsorsimilarbodieswitha

riskweightof20%50%Gold,equitysecurities,bondsratedA+to

A-65%Residentialmortgages85%Loanstoretailandsmallbusinesscustomerswitharemainingmaturitylessthanone

year100%Allother

assetsExampleAbankhasthefollowingbalance

sheet:Cash5RetailDeposits

(Stable)40TreasuryBonds(>1

year)5Wholesale

Deposits48Mortgages20Tier2

Capital4SmallBusiness

Loans60Tier1

Capital8FixedAssets1026-319100 100TheAmountofStableFunding

is:40×90%+48×50%+4×100%+8×100%=

72TheRequiredAmountofStableFunding

is:5×0%+5×5%+20×65%+60×85%+10×100%=

74.25NSFR=72/74.25=0.9697Thebankdoesnotsatisfythe

requirement.3.LiquidityBlack

Holes27-319Aliquidityblackholedescribesasituationwhereliquidityhasdriedupinaparticularmarketbecauseeveryonewantstosellandnoonewantstobuy,orviceversa.Itissometimesalsoreferredtoasa"crowded

exit.“Circuit

BreakerAliquidityblackholeiscreatedwhenapricedeclinecausesmoremarketparticipantstowanttosell,drivingpriceswellbelowwheretheywilleventuallysettle.Liquidityblackholestendtobeassociatedwithpricedecreases,butitisintheoryalsopossibleforthemtooccurwhentherearepriceincreases.3.LiquidityBlack

Holes28-319Negativefeedbacktradersbuywhenpricesfallandsellwhenpricesrise.Inliquidmarkets,negativefeedbacktradersdominatethetrading

.Positivefeedbacktraderssellwhenpricesfallandbuywhenpricesrise.Whenpositivefeedbacktradersdominatethetrading,marketpricesareliabletobeunstableandthemarketmaybecomeone-sidedand

illiquid.Thereareanumberofreasonswhypositivefeedbacktradingexists.Forexample:Trend

tradingStop-loss

rulesDynamic

hedging.Creatingoptions

syntheticallyMarginsPredatorytradingLTCM:shortliquidbondandlongilliquid

bondExerciseWhichofthefollowingstatementsregardingliquidityriskis

correct?Assetliquidityriskariseswhenafinancialinstitutioncannotmeetpaymentobligations.Flighttoqualityisusuallyreflectedinadecreaseintheyieldspreadbetweencorporateandgovernment

issues.Yieldspreadbetweenon-the-runandoff-the-runsecuritiesmainlycapturestheliquiditypremium,andnotthemarketandcreditrisk

premium.Fundingliquidityriskcanbemanagedbysettinglimitsoncertainassetmarketsorproductsandbymeansofdiversification.CorrectAnswer:

C29-319Liquidity

andLeverage30-319Chapter

2Framework1. TheSourceofFundingLiquidity

Risk31-319Marketsfor

CollateralLeverageTransactionLiquidity

RiskLiquidityRisk

MeasurementLiquidityandSystem

Risk1.TheSourceofFundingLiquidity

Risk32-319Maturity

TransformationMaturitymismatch:borrowatshorttermtofinanceinvestmentsthatrequirealongertimetobecome

profitable.Intermediariesengageinmaturitymismatchbecauseitisgenerallyprofitable.Fundinglong-termassetswithshort-termdebtexposesanintermediarytorollover-riskoreven

cliff-risk.Liquidity

TransformationTheprocessbywhichfinancialintermediariesusetheirbalancesheetstocreateassetsthatcanbeusedas

money.Marketparticipantsholdmoneytoconductliquiditytransactionsandforspeculativereasonssuchasrisk

preferences.Thedemandformoney-”liquiditypreference”,hasbecomeparticularlypertinentduringthesubprime

crisis.1.TheSourceofFundingLiquidity

Risk33-319FundingliquidityrisksofFinancial

Intermediaries①

Banks②Securities

Firms③MoneyMarketMutual

Funds④Hedge

Funds1.TheSourceofFundingLiquidity

Risk34-319Bank

liquidityThecorefunctionofacommercialbankistotakedepositsandprovidecommercialandindustrialloanstononfinancial

firms.Indoingso,itcarriesoutaliquidityandmaturity,aswellas

acredit,

transformation.Actually,bankscanalsotapthebroadercapitalmarketsandraisefundsbyissuingbonds,commercialpaper,andotherformsof

debt.AssetsEquities&

LiabilitiesCashandgovernmentbonds

$15Commonequity

$105-yearcorporateloans

$85Deposits$901.TheSourceofFundingLiquidity

Risk35-319FragilityofCommercial

BankingInafractional-reservebankingsystem,ifdepositorswishtomakewithdrawalsinexcessofabank’sreserves,andthebankcannotliquidateenoughloansorotherassetstomeetthedemandimmediately,itisforcedintosuspensionof

convertibility.Astheextreme,alloralargenumberofdepositorsmayaskforthereturnoftheirmoneysimultaneously,aneventcalledabank

run.Apartfromdeposits,banksaregenerallydependentonshort-termfinancing,exposingthemtorollover

risk.Rolloverriskistheriskthattheshort-termdebtcannotberefinanced,orcanberefinancedonlyonhighlydisadvantageousterms.1.TheSourceofFundingLiquidity

Risk36-319Asset-Liability

ManagementAligningavailablecashandshort-termassetswithexpectedrequirement.Keepingcertainratiosofreadycashandreadilymarketablesecuritiestomeetunusualdemandsbydepositorsandothershort-termlendersforthereturnoftheir

money.Fragilitycanbemitigatedthroughhighercapital,whichreducesdepositors’concernaboutsolvency,thetypicaltriggerofarun,andhigherreserves,whichreducesconcernabout

liquidity.1.TheSourceofFundingLiquidity

Risk37-319FundingliquidityrisksofotherintermediariesSecuritiesFirmsSecuritiesfirmsholdinventoriesofsecuritiesforsale,andfinancethembyborrowingatshort

term.BearStearnsCase:dependentonfreecashdepositsofthefirm'slargebaseofbrokerageandclearingcustomers,includingmanyhedge

funds.MoneyMarketMutual

FundsMMMFsprovideinstantliquidityfortheirinvestorsbygivingthemtheabilitytodrawontheiraccountsviachecksandelectronicbank

transfers.LiquidityriskcanjeopardizetheabilityofanMMMFtomaintaina$1.00netasset

value.Hedge

FundsHedgefundsfaceliquidityriskallthroughtheircapitalstructures.Hedgefundspermitinvestorstowithdrawtheirfundsatagreed

intervals.2.MarketsforCollateral38-319Marketsfor

CollateralMarketsforcollateralareformedwhensecuritiesareusedascollateraltoobtainsecuredloansofcashorother

securities.Firmscanborroworlendcollateralagainstcashorothersecurities.Ahaircutensuresthatthefullvalueofthecollateralisnot

lent.Majorformsofcollateral

marketMarginloansRepurchase

agreementsSecurities

lending2.MarketsforCollateral39-319Margin

loansLendingforthepurposeoffinancingasecuritytransactioninwhichtheloaniscollateralizedbythe

security.Purpose:Thesimplestformofamarketforcollateral,isprimarilyusedbyinvestorswishingtotakeleveragedlongpositionsinsecurities,mostoftenequities.Major

risksRepledge:Inpractice,thebrokerislikelytousethecustomer’scollateraltoborrowmoneyinthesecuredmoneymarkettoobtainthefundsitlendstomargincustomers.Collateralmayalsoberepledgedinordertoborrowanothersecurityratherthancashcollateral.Margin

callIfthemarketvalueoflongpositiondeclines,thebrokerlosestheprotectionthecollateralprovidesagainstthecustomerdefaultingonthemarginloan,sohewillissueamargincalltothe

customer.2.MarketsforCollateral40-319Repurchase

agreementsArematchedpairsofthespotsaleandforwardrepurchaseofsecurity.Thecollateralizationoftheloanisachievedbysellingthesecuritytemporarilytothe

lender.Purpose:Reverserepotransactionsaresimilar,inthattheyareoftenusedtofinancelongpositionsinsecurities,typicallybonds.Repotransactions,incontrast,areusuallyintendedtoborrowcashbyownersofbonds.Major

riskAfewdecadesago,repobegantoencompasshigh-yieldbondsandwholeloans,andmorerecently,structuredcredit

products.Themechanicsofrepolendingaresimilartomarginloans.Likemarginlending,repocreatesastraightforwardliabilityontheeconomicbalancesheet.2.MarketsforCollateral41-319Securities

lendingOnepartylendsasecuritytoanotherinexchangeforafee,generallycalledarebate.Thesecuritylendercontinuestoreceivedividendandinterestcashflowsfromthe

security.Therearetwotypicalpatternsofsecurities

lendingTheinvestormakestheequitiesavailableforlendingbyholdingthematthecustodianorprimebrokerin“streetname”,

sothattheycanberehypothecatedtoatraderwhowishestosellthesecuritiesshort.Atypicalfixed-incomesecuritieslendingtransactionaimstoearnaspreadbetweenlessandmore-risky

bonds.Purpose:Securitieslendinghastypicallybeenfocusedonthesecuritiesratherthanthecashcollateral,typicallytoestablishshortpositions.Inrecentyears,thefocusoftheirusehasshiftedtoborrowingcashcollateral.2.MarketsforCollateral42-319EconomicFunctionofMarketsfor

CollateralFirst,theycreatetheabilitytoestablishleveragedlongandshortpositionsin

securities.Second,collateralmarketsenhancetheabilityoffirmstoborrow

money.RisksinMarketsfor

CollateralTherisksinmarketsforcollateralaresimilartothoseofotherleveragedpositions.Theycomprisemarket,credit,andcounterparty

risks.Thesizeandstructureofcollateralmarketsalsocontributestosystemicrisk.Drastic

remargin3.LeverageLeverageratioisdefined

asL=A=1+

DE ELeverageeffect:Leverageisimportantbecauseitprovidesanopportunitytoincreasereturnstoequity

investors.Theleverageeffectistheincreaseinequityreturnsthatresultsfromincreasingleverageandisequaltothedifferencebetweenthereturnsontheassetsandcostof

funding.Re=L×Ra−(L−1)×

Rd43-3193.LeverageTwoformsofleveraged

returnHaircutandrepo

transactionToseethis,denotethecouponratebyc,thehaircutbyh,andthereporatebyr,andassumec>r(allin

percent).ℎTheleverageisequalto

1.Theleveragedreturn,

is𝑐𝑐

− 1

−

ℎ ×𝑟𝑟

=c+1

−

ℎ 𝑐𝑐

−

𝑟𝑟

ℎ ℎLeveragedreturnstohousing(Assuming10%price

appreciation)Leverage=1/down

payment(%)44-3193.Leverage45-319Impactofdifferenttypesoftransactionsonafirm'sleverageandbalance

sheet.MarginloansShort

positionsDerivativesWetakeasthestartingpointofafirm,A,with100incash,correspondingtoaninitialplacementof100inequitybyits

owners.Thebalancesheetonopeningday

is:AssetLiabilitiesCash100Equity

100Debt03.Leverage46-319Marginloansand

leverageAssumeFirmAfinancesalongpositionin100worthofanequityatthemarginrequirementof

50%.Thebrokerretainscustodyofthestockascollateralfortheloan.FirmA’sfulleconomicbalancesheet,includingtheentriesinitsmarginaccount

isThefirm’sleveragehasrisenfrom1to

1.5.AssetLiabilitiesCash50Equity

100Stock

value100Marginloan

503.Leverage47-319ShortpositionsTocreateashortpositioninastock,FirmAborrows100ofthesecurityandsells

it.Thecashcannotbeusedtofundotherinvestments,asitiscollateral.Itremainsinasegregatedshort

account.Thestockmightriseinprice,inwhichcasethe100ofproceedswouldnotsufficetocoveritsreturntotheborrower.FirmAmustputupmarginof

50.Firm

Asfulleconomicbalance

sheet

isThefirmhasgonefromleverageof1to

2.’ AssetLiabilities50cashEquity

100150duefrom

brokerBorrowedstock

1003.Leverage48-319ShortpositionsIfshortpositionsplayahedgingroleintheportfolio,leveragewilloverstatetherisk,sinceaddingtheshortpositionsincreasesleverage,butreducesmarketrisk.Thisleadstoadistinctionbetweengrossandnet

leverage.Grossleverage:thesumofalltheassetvalues,includingcashgeneratedbyshortsorassetsacquiredwiththatcash,dividedbycapital.Itcanbethoughtofasthetotal“length”ofthebalancesheetdividedbythe

capital.Netleverage:theratioofdifferencebetweenthemarketvaluesofthelongandshortpositionstothe

capital.3.Leverage49-319Leverageand

derivativesEachsideofaderivativescontractissyntheticallylongorshortanasset.Formeasuringeconomicleverage,weneedtofind,foreachtypeofderivative,acash-equivalentmarket

value.Futures,forwards,andswaps:arelinearandsymmetricinunderlyingassetpriceandcanbehedgedstatically.Options:haveanonlinearrelationshiptotheunderlyingassetpriceandmustbehedgeddynamically,inthatcase,theleveragewillvaryover

time.3.Leverage50-319LeverageandStructured

CreditStructuredcreditalsoprovidesembedded

leverage.Thebondtranchestakelossesonlyinmoreextremedefaultandcorrelationscenarios.Theequitynotebearsmostoftheriskof

loss.AssetVolatilityand

LeverageInvestinginassetswithahigherreturnvolatilityiseconomicallyquitesimilartoleverage.Anassetwithmorevolatilereturnsprovidesahigherprobabilityofhigherleveragedreturnstotheinvestor,butalsoahigherprobabilityoflossestotheproviderof

credit.4.TransactionLiquidity

Risk51-319TransactionliquidityriskisultimatelyduetothecostofsearchingforacounterpartyCostoftrade

processing.Inventorymanagementby

dealers.Theroleofdealersistoprovidetradeimmediacytooth