Liquidity risk

Definition

Liquidity risk is the risk that an investor will not be able to buy or sell a bond quickly enough in the market to prevent or minimize a loss. It arises when there is insufficient market demand for selling the asset at its current value.

5 Must Know Facts For Your Next Test

1. Liquidity risk is higher for bonds with lower trading volumes.
2. It can lead to significant price discounts when trying to sell a bond quickly.
3. Liquidity risk is often measured by the bid-ask spread in the market.
4. Investors may demand higher yields for bonds with higher liquidity risk.
5. Government bonds typically have lower liquidity risk compared to corporate bonds.

Review Questions

• What factors contribute to liquidity risk in bonds?
• How does liquidity risk affect bond prices and yields?
• Why do government bonds generally have lower liquidity risk than corporate bonds?

Related terms

Interest Rate Risk:

The potential for investment losses due to fluctuations in interest rates.

Default Risk:

The possibility that a bond issuer will fail to make required payments of principal or interest.

Bid-Ask Spread:

The difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.