Try 10 focused CISI Risk questions on Liquidity Risk, with answers and explanations, then continue with Securities Prep.
| Field | Detail |
|---|---|
| Exam route | CISI Risk |
| Issuer | CISI |
| Topic area | Liquidity Risk |
| Blueprint weight | 10% |
| Page purpose | Focused sample questions before returning to mixed practice |
Use this page to isolate Liquidity Risk for CISI Risk. Work through the 10 questions first, then review the explanations and return to mixed practice in Securities Prep.
| Pass | What to do | What to record |
|---|---|---|
| First attempt | Answer without checking the explanation first. | The fact, rule, calculation, or judgment point that controlled your answer. |
| Review | Read the explanation even when you were correct. | Why the best answer is stronger than the closest distractor. |
| Repair | Repeat only missed or uncertain items after a short break. | The pattern behind misses, not the answer letter. |
| Transfer | Return to mixed practice once the topic feels stable. | Whether the same skill holds up when the topic is no longer obvious. |
Blueprint context: 10% of the practice outline. A focused topic score can overstate readiness if you recognize the pattern too quickly, so use it as repair work before timed mixed sets.
These questions are original Securities Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.
Topic: Liquidity Risk
An enforceable bilateral cash-netting agreement covers all GBP payments due today between Firm A and Firm B. Firm A owes Firm B £7.2 million and £1.8 million. Firm B owes Firm A £5.5 million and £0.9 million. Which outcome matches the effect of the cash-netting agreement on today’s settlement cash flow?
Best answer: C
What this tests: Liquidity Risk
Explanation: Cash netting offsets reciprocal same-day obligations and leaves a single balance to settle. Firm A owes £9.0 million in total and is due £6.4 million, so the net payment is £2.6 million from Firm A to Firm B.
The core concept is bilateral cash netting: instead of each side making all gross payments, the agreement offsets amounts payable and receivable in the same currency and settlement period. Here, Firm A’s total payable is £9.0 million and its total receivable is £6.4 million, so the remaining balance is £2.6 million payable by Firm A.
This reduces gross cash movements and therefore supports liquidity management, but it does not create collateral or funding.
Cash netting offsets mutual obligations, leaving only the £9.0 million less £6.4 million balance payable by Firm A.
Topic: Liquidity Risk
In liquidity risk management, which cash-flow input is usually based on a behavioural assumption rather than a contractual cash-flow fact?
Best answer: D
What this tests: Liquidity Risk
Explanation: Behavioural liquidity assumptions estimate how customers or counterparties are likely to act when contracts do not fully fix cash-flow timing. Instant-access deposits have no stated maturity, so expected run-off must be modelled from likely depositor behaviour.
The key distinction is between legally fixed cash flows and estimated cash flows. Contractual cash-flow facts come directly from the terms of an instrument, such as bond coupon dates, term-funding maturities, and scheduled loan repayments. Behavioural assumptions are used when the contract allows flexibility or optionality, so actual timing depends on likely actions by customers or counterparties under normal or stressed conditions. Common examples include the stability of non-maturing deposits, early loan prepayments, and expected drawings on facilities. Because instant-access retail deposits can usually be withdrawn at the customer’s discretion, their expected run-off in a liquidity plan is behavioural rather than contractual. The practical test is whether the date and amount are fixed by contract or inferred from behaviour.
Run-off of on-demand deposits depends on expected customer behaviour, not a fixed contractual maturity.
Topic: Liquidity Risk
A broker-dealer funds most of its corporate bond inventory through overnight repo. It usually rolls this funding daily and keeps only a small cash buffer. After a sharp market sell-off, repo haircuts on the bonds rise from 3% to 12%, and one of its two main repo counterparties refuses to renew. Which development is the clearest sign that this has become a liquidity-risk event?
Best answer: A
What this tests: Liquidity Risk
Explanation: A funding position becomes a liquidity-risk event when market stress both increases immediate cash demands and reduces access to funding. Here, higher repo haircuts and the loss of a key rollover counterparty create an urgent refinancing and collateral problem, not just tougher market conditions.
Liquidity risk is the risk that a firm cannot meet cash outflows as they fall due without unacceptable cost or disruption. In this scenario, the broker-dealer depends on concentrated overnight repo funding. The market sell-off increases haircuts sharply, so more cash or collateral is needed, while one of only two repo counterparties withdraws funding. That combination turns a normally manageable daily rollover process into a liquidity event because the firm faces immediate cash pressure and reduced market access at the same time.
A mark-to-market loss is mainly market risk unless it creates funding calls. An outdated policy is a control weakness, and higher funding cost alone is not yet a liquidity event if funding remains available. The key sign is simultaneous cash strain and loss of refinancing capacity.
Liquidity risk crystallises when stressed conditions create same-day cash needs and normal funding can no longer be rolled.
Topic: Liquidity Risk
Which description best defines funding liquidity risk for a financial-services firm?
Best answer: D
What this tests: Liquidity Risk
Explanation: Funding liquidity risk is about the firm’s ability to obtain cash to meet obligations as they fall due. If meeting outflows requires unusually expensive borrowing or hurried asset sales, the firm has a funding liquidity problem.
The core concept is the distinction between having cash available and being able to trade assets. Funding liquidity risk arises when a firm may be unable to meet withdrawals, margin calls, or other payment obligations on time without paying excessive funding costs or selling assets in a distressed way. That is different from market liquidity risk, which focuses on whether an asset can be sold quickly at or near its fair value. Credit risk concerns non-payment by a borrower or counterparty, while losses that erode capital point more to solvency or capital adequacy concerns than to liquidity itself. The key takeaway is that funding liquidity is about cash-flow needs and access to funding, not mainly asset marketability.
Funding liquidity risk is the risk that the firm cannot obtain cash as needed except at unacceptable cost or through distressed actions.
Topic: Liquidity Risk
What is the main purpose of funding-liquidity-risk analysis in a financial institution?
Best answer: B
What this tests: Liquidity Risk
Explanation: Funding-liquidity-risk analysis is about whether a firm can obtain cash to meet obligations when needed, including under stress. It uses tools such as liquidity-gap analysis and stress testing to assess future funding shortfalls and the firm’s ability to cover them.
The core concept is funding liquidity risk: the risk that a firm cannot meet its payment and collateral obligations as they fall due, except at an unacceptable cost. Funding-liquidity-risk analysis therefore looks forward to expected future funding requirements, identifies timing mismatches between inflows and outflows through liquidity-gap analysis, and tests resilience under adverse conditions through stress testing.
A firm may appear sound in capital terms yet still face serious liquidity pressure if cash cannot be raised in time. That is why liquidity measurement focuses on cash-flow timing, rollover risk, contingent outflows and stressed funding access, rather than only on solvency or investment performance.
The closest distractor describes market liquidity risk, which is related but different from funding liquidity risk.
Funding liquidity risk analysis focuses on the firm’s ability to meet future cash outflows in normal and stressed conditions.
Topic: Liquidity Risk
A fund must sell £1.5 million nominal of a corporate bond immediately during a market dislocation. Prices are percentages of par.
Exhibit:
Ignoring fees, what is the fund’s average execution price, and what does this best illustrate?
Best answer: B
What this tests: Liquidity Risk
Explanation: The first £500,000 sells at 99.40 and the next £1,000,000 at 98.80, so the weighted average execution price is 99.00. This illustrates market dislocation: liquidity is thinner, so executable prices can be materially worse than headline or reference prices.
Market dislocation affects both pricing and execution because the visible best price may only be available for a limited size. Here, the fund cannot sell the full £1.5 million at 99.40, because that bid only covers £500,000.
(500,000 × 99.40 + 1,000,000 × 98.80) / 1,500,000 = 99.00That lower average execution price shows reduced market depth and higher execution slippage in stressed conditions. The prior close is only a reference point, and the ask is relevant to a buyer, not to a seller needing immediate liquidity. The key takeaway is that dislocation can make realisable value materially lower than screen prices suggest.
Only £500,000 can be sold at 99.40, so the rest executes at 98.80, giving a weighted average of 99.00 and showing reduced market depth.
Topic: Liquidity Risk
A bank funds part of a 90-day loan book with 7-day wholesale deposits. New deposit spreads have widened by 40 basis points and loan prices are unchanged, but Treasury’s cash-flow ladder shows only 60% of £300 million maturing deposits are likely to roll, creating a projected £90 million cash shortfall within 7 days. The firm’s risk appetite requires escalation of any projected cumulative shortfall within 30 days. Which response best applies sound liquidity-risk management?
Best answer: C
What this tests: Liquidity Risk
Explanation: This is a funding-gap problem because the cash-flow ladder shows a projected shortfall within seven days, driven by incomplete rollover of maturing deposits. Wider spreads are secondary; once the shortfall breaches the firm’s stated risk appetite, the correct response is to escalate and activate contingency funding.
A funding-gap problem arises when expected cash outflows exceed reliable inflows or available liquid resources over the relevant time horizon. In this scenario, the key fact is not that wholesale funding has become more expensive; it is that only part of the maturing deposits is expected to roll, leaving a projected £90 million shortfall within seven days. That is a liquidity measurement issue shown by the cash-flow ladder and it breaches the firm’s escalation trigger for any cumulative shortfall within 30 days.
If funding were still fully available but only at a higher spread, that would be mainly a pricing problem. Here, however, availability is insufficient, so the appropriate response is escalation and use of contingency funding sources. Stable loan prices do not remove the near-term refinancing gap.
A projected cash shortfall inside the risk-appetite horizon is a funding-gap breach, so it should be escalated and covered through contingency funding.
Topic: Liquidity Risk
A securities dealer finances a large inventory of corporate bonds through overnight repo. Several peer dealers hold similar bonds. The CRO wants to identify liquidity risk in a way that captures both the dealer’s own vulnerability and the risk of wider market disruption. Which action best applies a sound risk-management principle?
Best answer: D
What this tests: Liquidity Risk
Explanation: The best approach is to combine firm-specific and market-wide liquidity stresses. That shows how the dealer could be affected by its own funding weakness and by system-wide effects such as tighter repo terms and fire-sale pressure in commonly held assets.
Liquidity risk should be identified through scenarios that cover both an individual firm shock and a market-wide shock, because the two often reinforce each other. In this case, reliance on overnight repo creates funding fragility, while common holdings across peer dealers create the risk of falling prices and reduced market depth if several firms try to sell at once. A sound stress-testing approach therefore includes funding runoff, higher collateral haircuts, shorter tenors and asset-sale discounts, then compares the outcome with the firm’s liquidity risk appetite and escalation triggers.
The key point is that liquidity risk is not just about today’s market prices; it is about whether cash can still be raised in stressed conditions without destabilising the firm or adding to wider market strain.
This approach tests both idiosyncratic and systemic liquidity pressure and links the results to risk appetite and escalation.
Topic: Liquidity Risk
A firm uses very short-term wholesale borrowing to avoid forced sales of less liquid assets. This reduces immediate market liquidity pressure, but it most directly increases exposure to which risk?
Best answer: C
What this tests: Liquidity Risk
Explanation: Using short-term borrowing can help a firm avoid selling assets into a weak market, so it eases market liquidity pressure. However, it increases dependence on continued access to funding, which is the essence of funding liquidity risk.
The core concept is the difference between market liquidity risk and funding liquidity risk. Avoiding forced asset sales reduces the risk of having to sell assets quickly at depressed prices, which is market liquidity pressure. But replacing that pressure with very short-term borrowing means the firm must refinance or roll over funding frequently. If wholesale markets tighten or lenders withdraw, the firm may be unable to meet cash needs when due. That new vulnerability is funding liquidity risk.
The closest confusion is market liquidity risk, but that is the pressure the action is designed to reduce, not the main risk it creates.
Reliance on short-term borrowing creates rollover and refinancing vulnerability if funding cannot be renewed when needed.
Topic: Liquidity Risk
Which term describes the risk that a firm cannot exit a sizeable position quickly at, or close to, the current market price because market depth is limited and prices do not recover quickly after trades?
Best answer: A
What this tests: Liquidity Risk
Explanation: Limited market depth means there are not enough buyers or sellers to absorb a trade without moving the price, and poor resilience means prices do not bounce back quickly after trading pressure. Together, these are classic features of market liquidity risk.
Market liquidity risk is the risk that a position cannot be sold or hedged promptly without a material price concession. In this context, depth refers to how much volume the market can absorb at or near the current price, while resilience refers to how quickly prices recover after a trade or order imbalance. If depth is thin and resilience is weak, exiting a large position becomes harder and more expensive, even if the asset still has an observable market price. That differs from funding liquidity risk, which is about obtaining cash to meet obligations, and from market risk, which is about adverse price movements themselves rather than the ability to trade.
This is market liquidity risk because thin depth and weak resilience make it difficult to unwind a position near the prevailing price.
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