Question

(c) An FI has 2 kinds of assets: 60% in 1 month T-bill and 40% in 1 month consumer loan. In a month, the T-bill will yield $100, but now it worths only $97. The consumer loan will yield $88 in a month, but now it is worth $76. Calculate the 1 month liquidity index.

(d) Refer to (c), if the market conditions change suddenly and the T-bill now worths $98, while the consumer loan worths $72. Calculate the new 1 month liquidity index.

(e) Based on the results from (c) and (d), interpret the liquidity risk faced by the FI before and after the market conditions change.

Answer 1

Sol:

c) 1 month T-bill weight = 40%

1 month consumer loan weight = 60%

T-bill yield per month = $100, Current worth = $97

Consumer loan yield per month = $88, Current worth = $76

1 month liquidity index = 1 month T-bill weight x (Current worth T bill / T-bill yield per month) + 1 month consumer loan weight x (Current worth Consumer loan / Consumer loan yield per month

1 month liquidity index = (60% x ($97/100)) + (40% x ($76/$88))

1 month liquidity index = (0.60 x 0.97) + (0.40 x 0.8636)

1 month liquidity index = 0.582 + 0.3455 = 0.93

d)1 month liquidity index = (60% x ($98/100)) + (40% x ($72/$88))

1 month liquidity index = (0.60 x 0.98) + (0.40 x 0.8182)

1 month liquidity index = 0.588 + 0.3273 = 0.92

e) Liquidity index value lies between 0 and 1. If it is closer to zero than liquidity risk is high and if it is closer to 1 then liquidity risk is low. In above two cases, liquidity index value in (d) is less than the liquidity index value in (c). Therefore liquidity risk will be higher in case of (d).