GARP 2016-FRR Exam With Confidence Using Practice Dumps

Most loans and deposits in the interbank market have a maturity of less than one year. This short-term nature is due to the need for liquidity and flexibility among banks, allowing them to manage their short-term funding requirements and respond to changes in interest rates and market conditions effectively.

Funding liquidity risk and trading liquidity risk are two distinct types of liquidity risks faced by financial institutions, particularly banks.

Funding Liquidity Risk:This type of risk pertains to a bank's ability to meet its financial obligations as they come due without incurring unacceptable losses. It primarily concerns the bank's ability to fund withdrawals, meet depositor demands, and other liabilities when they come due. If a bank cannot manage its funding liquidity, it may be forced to sell assets at fire sale prices, which can further deteriorate its financial condition.

Trading Liquidity Risk:This risk, on the other hand, deals with the market liquidity of the bank's assets. It involves the risk of being unable to buy or sell assets at or near their market value due to inadequate market depth or market disruptions. It is more concerned with the bid-offer spreads and the ability to execute trades without significantly impacting the market price of the asset.

In the context of options trading, delta hedging involves managing the delta (rate of change of the option's price with respect to changes in the underlying asset's price) to be neutral.

Options premium: Represents the cost paid to eliminate execution risk associated with sudden market moves (gapping markets).

Execution risk: The risk of being unable to adjust positions quickly enough in response to market changes.

By purchasing options, the trader removes the risk of needing to adjust a delta-neutral position during large market movements. The premium paid is the cost of this protection.

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Source: How Finance Works​