Question

3. A financial institution has the following assets (market values):

$120 million in cash reserves,

$120 million in Treasury bills and notes,

$200 million in mortgage loans,

$40 million in corporate bonds, and

$150 million in commercial loans.

If assets are liquidated on short notice, the institution expects to receive

99% of the fair market value of the treasury debt,

90% of the fair market value of the mortgages,

95% of the fair market value of the bonds, and

$75% of the fair market value of the commercial loans.

What is the financial institution’s liquidity index?

Answer 1

The liquidity index

• Reflects reflects the amount realized from a fire-sale of assets compared to a fair market value established under the conditions of normal sale.
• In a way helps us understand, potential losses suffered by a financial institution (FI) from a fire-sale of assets compared to a fair market value established under the conditions of normal sale.
• The lower is the index, the less liquidity the FI has on its balance sheet.
• The index should always be a value between 0 and 1.   

Financials below are in $ million.

Asset	Fair Value	Realization factor	Amount Realized
	FV	R	A = R x FV
Cash Reserves	120.00	100%	120.00
Treasury bills & Notes	120.00	99%	118.80
Mortgage loans	200.00	90%	180.00
Corporate bonds	40.00	95%	38.00
Commercial loans	150.00	75%	112.50
Total	630.00		569.30

the financial institution’s liquidity index = Total of A / Total of FV = 569.30 / 630 = 90.37%