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What are the major risks resulting from financial instruments?
Liquidity Risks
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Most institutions face two types of liquidity risk. The first relates to the depth of markets for specific products and the second to funding the financial-trading activities of the firm. When establishing limits for various major risk types and products, senior managers must factor in the size, depth and liquidity of a particular market or product, because the liquidity of the market/instrument affects the ability of the firm to alter its risk profile quickly and at a reasonable cost. Some firms, for example, even have contract limits for every futures contract based on the volume of turnover and outstandings. Senior managers must also develop procedures to identify and monitor the firm’s liquidity sources to ensure it can meet the funding demands of its activities. This is achieved by monitoring the differences in maturities between assets and liabilities and by analysing future funding requirements based on various assumptions, including the firm’s ability to liquidate positions quickly in adverse conditions.
Firms which deal in the over-the-counter market must also draw up contingency procedures to deal with potential liquidity risks that may rise from the early termination of contracts.
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Case Studies *
13 Questions on Risk Management *
What are the major risks resulting from financial instruments?
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