Two Different Types of Liquidity Risk - Essay Example

 Liquidity risk is the risk that a particular asset or security bears, thus it cannot be traded in a manner quick enough to prevent a loss in the market. It is in it, there exists two different types of liquidity risk. This are, market liquidity, and n the other hand, is funding liquidity. Both of these in a nutshell, constitute the measures and levels of liquidity risk. Upon experiencing market liquidity, the relative asset cannot be sold, if at all it lacks liquidity in the market. This might be as a result of having made explicit liquidity reserves or having widened the bid spread. Similarly, the lengthening of the holding period for Value-at Risk calculations has its effect on matters concerning market liquidity. On the other hand, on the issue of funding liquidity, risk liabilities affiliated to these may vary in a wide range. Funding risk sorts to risk for liabilities that tend not to have been met, when they fall due. Liquidity risk tends to be duly managed, putting to consideration an addition to the credit, market, and other risks involved. The issue of bank risk revolves around several types of risks, all incorporated s one bring life to the initial bank risk. A banking risk framework provided by the Federal Reserve System, sites six factors constituting the bank risk. These include, Credit risks, market risks, legal risks, reputational and liquidity risk. The structures of risk management are thus reviewed, making use of these risk categories. Revelation by majority of Federal Reserve banks is that supervision groups concerned with these firms, follow current risks, and continue to fight against emerging risks as well. This processes trend on a continuous basis, and as a result, measures to counter the existence of so many opportunities that may result to risk, are initiated (Choudhry 64). The terms financial risk, could more or less be used to refer to majority of situations surrounding the existence of bank risk. This is because, financial Risk, and financial risk management refers to the practice of creation of economic value in a firm, while making use of financial instruments. When translated to the banking sector, it makes use of financial banking instruments instead, to control the exposure to risk (Fight 102). The management of these risks related to banks, and the whole subject of banking, falls to one of two categories. They can either be qualitative, or on the other hand, quantitative. As a result of the banking sectors specialization in the management of the risks involved, bank risk management aims at focusing on when it could be considered most favorable, as well as how they would hedge, making use of financial instruments, all with bigger aim to manage costly risk exposure (Jafee 118). Basel Accords tend to be adopted in the banking sector worldwide, and go a step further, to be adopted by international banks that are rather active, for the purpose of reporting operational risks, as well as exposing operational market risks, and credit risks. In view of the finance theory, it is prescribed that banking institutions, and firms, should take on a move to carry out a project, when there is increase in the shareholder value. The theory of finance too, with relevance to the issue of bank risks, shows that managers of firms, especially banking institutions, are not at a position to create value for the shareholders themselves, by facilitating the operation of projects that the shareholders are capable of doing for themselves, at more or less, the same cost (Morrison 128). This only translates to the suggestion that, bank managers are capable, and have many opportunities for value creation for the shareholders, suppressing the event of risk occurrence on the side of the banking sector. This is mainly, by the use of proper management of underlying financial risks. The trick that lies here is for the banks to discover or rather determine as to which are cheaper for the institution to manage (Walsh 169). The concepts and ideologies governing management of financial risks, most especially in the banking sector, tend to be more or less similar, in the event of considering major banks all round the world. Corporate that are multinational however, are faced with similar obstacles, in overcoming challenges related to risk and risk management. Banking firms and institutions around the globe, should also consider the fact that the issue of foreign exchange exposure, the exposure to all kinds of transactions and finally accounting and economic exposure, pose as a huge facilitator, towards the realization of risks in the banking sector. In matters concerning Real Estate crises, there lays a perfect example that matches up with the definition of the term in the United States. This is as in the case of The United States housing bubble, an economic bubble, which affected most regions of the United States housing market. This constituted of a number of states men of a little over half of the American states. It is in this and much similar cases, that there erupted Real Estate crisis. Research reveals that housing prices peaked exubilantry in the early 2006 but has since then been on the high decline till to date. The credit crisis resulted from the bursting of the housing bubble. According to prior statistics, it is provided that, such crises constitute a huge proportion, as the primary cause of the 2007-2009 recession, of the United States. In separate, though related situations, experiencing increased foreclosure rates, among the homeowners in the United States, resulted to a crisis. This involved the subprime and collateralized debt obligation. It stretched its crisis effects, unto the mortgage department sectors, the credit, foreign bank and hedge fund markets. Relative collapse of the U.S housing bubble, facilitated greatly, and had direct impact, not only towards home valuation, but to the nation’s mortgage markets as well. Home builders, real estate agents and home supply retailers, also suffered the effect of the crisis. The hedge funds, directly affiliated with Wall Street, held previously by major investors, hand in hand with foreign banks, thus there existed an increase in the levels of risk that brought about the chances of a nationwide recession (Narusis 200). As a result of the critical impact of collapsing housing, as well as credit markets mainly around the larger United States economy, raised concern prompting the announcement of limited bailout of the United States housing market from the higher state-management. This is mainly for those particular home owners who lie liable for payment of their mortgages, but are incapable to do so (Reuvid 245). In reference to prior research, it is revealed that in the year 2008, the government of the United States, allocate huge sums of money, amounting to billions of dollars. These were aimed at funding special loans and rescues as well, all related to the U S housing bubble. Government-sponsored enterprises get the upper hand, in the overall beneficiary of this funding. Such acts and proceedings rule in disfavor of the Housing and Economic Recovery Act, of 2008. In site o an example, some of the government sponsored enterprises, are acknowledged to be making huge losses, and despite that fact, continue receiving aids and grants as well. This overshadowing of the real estate sector, adds up to the factors facilitating the experiencing of relative crises. As recorded from separate research, building costs index indicate, land prices are seen to contribute greatly towards price increases, far much more than structures. Estimates of land value, and the put up house, can be derived easily, by subtracting the replacement value of the structure itself. This replacement value is priory adjusted in favor of situations concerned with depreciation, from the home price. This methodology of information gathering resulted to calculation of values of land, for certain metro regions in the United States. The situation housing bubbles may have occurred in both local and global real estate markets as well. At later stages, the situation is characterized by increases in the rate of valuation of property, and real estates in particular. This is the situation until the moment whereby, levels that lie unsustainable are realized, all this in relevance to incomes. Other independent economic indicators reveal the same, in relation to certain relevant ratios (Choudhry 100). In a much similar situation, the mortgage and credit crisis is experienced, having risen from the incapability of a relatively high number of home owners, to pay up for their mortgage, thus giving rise to the situations reverting to regular rates of interest. As home prices remain in the view of the public as overvalued, the correction to this particular situation would last for a long time. This would consequently affect negatively, the wellbeing of home value, since a huge amount of money would be lost in the process (Reuvid 112). At a given time, the world economy braced for the possibility of the exit of the Greek from the Euro system. This was as a result of the occurrence of the infamous European debt crisis. This was a situation whereby Europe as a continent experienced major struggle, in the effort to pay up the debts that had built up over the past decades. Several countries, with the inclusion of Greece, had failed to facilitate enough economic growth, for them to be at a position to serve bondholders with the expected payback. The crisis however, left the rest of the world, with the risk of suffering its consequences, whether directly, or indirectly. It was referred to as one of the most crucial problems, which currently face world economy at large. The crisis lied very difficult for any particular body to comprehend, as well as solve. The crisis came up as a result of the exposure, of European economies, to fiscal policies that lay in practice throughout the continent. High budget deficits too were unsustainable, since with slow growth rate of the economies, followed the slow growth of revenues generated from taxes. Further research proved that, debts owed by Greece alone, were overwhelming, to the extent that, they exceeded the overall amount in the nations entire economy. Consequently, the country was not able to conceal the issue from public knowledge. Investors who had put up their deals in this economy, as a result, responded by demanding higher yields on Greece’s bonds. The scenario raised the cost of the country’s debt burden and brought about the necessity of a series of bailouts by the European Union. Markets too, also began driving up the yields from bonds, in the other heavily indebted countries in the region, anticipating problems similar to what had been experienced in Greece. The European Union, and other major bodies, has since this occurrence, taken action, though it has moved slowly. This is since it obtained the consent of all nations in the union. The primary course of action resulted to this far has undoubtedly been a series of bailouts for Europe’s troubled economies. The European Central Bank also, was involved. Although actions taken by European policy makers, helped stabilize the financial markets involved in the short term, they were widely criticized. Greece however, had the main advantage, of lying vulnerable, to rescue by the European Central Bank, due to its small size in nature. The dangerous and unstable state of the countries’ fiscal health was therefore a major issue for the markets at various points. Unfortunately, the solution is not, and never was that simple. This is because, the European banks remain one of the largest holders of region’s government debt, although they reduced their positions at some point. Rules governing the operation of this institutions, governed that Banks are required to keep a certain amount of assets. This is on their balance sheets, relative to the amount of debt the individuals hold. Recovery of this sector however, lies non-guaranteed, since he prices were falling greatly. On the other hand, the impact of overstated home valuations on the economy of the United States, especially during the 2001-2002 recessions played an important role in facilitating recovery. This being supported by the large consumer component spending that had the refinancing boom fuel it. This allowed clients to bear reduced mortgage payments monthly, which constituted lower rates of interest and brought rise to the ability to withdraw equity from client’s homes, as their relative value continued to increase (Choudhry 267). It is evident that majority of this case-scenarios are not expected, as many ought to contest suggestions that the housing bubble would experience its peak, warning that the crisis alarm had no basis, especially with reference to the real-estate sector. Real estate crisis escalate further, to higher levels, citing the example of an instance whereby, the Federal Reserve’s administration, warned of risks posed by subprime mortgages. It is rather important to note the fact that, throughout the period dominated by the bubble, in reference to a crisis situation, there existed minimal or no mention or highlight of the prevailing fact that, housing, and real estate business continued to flourish in the country, without stop, and did not come to a halt, at any moment. However, despite their uninterrupted running, marked data statistics revealed that they experienced a marked decline in sectors, bringing about raising inventories, yet lower sales. They further experienced reducing median prices, with increasing rates of foreclosure. The recorded data, with the incorporation of verified statistical results, would vividly translate to advising the public to withdraw their concern from the rising home prices. This is as compared to the average levels of family income that do not rise proportionally, but to put to consideration the possibility of realization of no risk, of a housing price bubble, all this being based on predictable economic factors, that are concerned with the non-ending business practice, especially in the real estate sector (Fight 144). In matters concerning supply chain management, Supply Chain Management is a practice that incorporates various management traits in an effort to identify and interconnect the processes involved in the provision of goods and at times services. The chain flows from the initial generator of the raw materials to the final person to benefit from the product, that is, the customer. In any business practice, risks are some of the most important aspects to recognize and the management of these threats helps in making the flow of work better and that of the products faster and thus the importance of carrying out research on how to best manage them (Willett 242). In the markets, lies firms such as Ray Brooks Company, which exercises systematic probabilistic risk assessment, whereby the management of the company and the administration in general executes systematic and comprehensive methodologies. In the matters concerning the safety of the company in the near future, the final call lies upon the ultimate decision, reached to by the superiors. This includes those who are in charge of the company, with an aim to try as much as possible, to predict what the future holds good tidings in store for the company. Scenarios such as these hold the final call, on whether the company is vulnerable to intense competition, rising from new rivals, who enter into the market. Risk situations affect independent companies too, with a good example of Ray Brooks, a leading company in footwear industry for a number of decades. It initially targeted official footwear, which includes school wear and other related office wear. The ray brook shoes have dominated the shoe market in the entire world from the 80s. Its journey started as a single retail outlet, its rise in the shoe market has seen the opening of at least 50 stores in most of the Asian countries and other countries world with the said range of numbers (Nicholas 188). This led to the expansion of the company stretching its wings to other countries, which increased the rebranding of the name in order to fit in the international market; this led to the R.BROOKS LIMITED Company, which was internationally recognized worldwide. The founder who still stands as the managing director up to date designed the innovation and design of the first shoes. The change in times led to the development of different types of makes and modification which made the company to fit in the world market. This led to the creation of the new models, which fit with latest fashion and designs. The company production and manufacture rose as the company merged with other companies. Despite the minimal contribution, or rather participation of the Lehman Brothers in the case study in question, it may prove necessary to discuss some underlying factors that revolve around the mentioned. Lehman stood as the fourth-largest investment bank in the United States. It however fell bankrupt, leading to a major financial crisis of its sort. It was in business through investment banking, and other categories of business, that all linked up as one big source of income generation. The firm lay under the establishment by the Lehman family, particularly Emanuel and Mayer Lehman, two brothers. The two had spot potential business opportunities, and entrepreneurial title, in the cotton industry. It is thus, that they capitalized on the high market value of the cotton, making way to being among the high income generators, contributing to the growth of the economy. The center of cotton trade has since then, undergone very critical and thorough transformation, starting from the shift from the south New York City, to localities that favored the business practice way less. The firm however, was involved in major mergers and business partnership, with the aim to try and sustain itself, in within the ever-changing world markets. The firm went a step further, where it made known its presence, during the sad and unfortunate terror attacks, of 9/11. Work Cited Choudhry, Moorad. An introduction to banking liquidity risk and asset-liability management. Chichester, U.K.: John Wiley & Sons, 2011. Print. Fight, Andrew. Credit risk management. Oxford: Elsevier, 2009. Print. Jaffee, Dwight M.. The Swedish real estate crisis. Berkeley: Institute of Business and Economic Research, University of California at Berkeley, Center for Real Estate and Urban Economics, 2010. Print. Fight, Andrew. Understanding international bank risk. Chichester, West Sussex, England: John Wiley & Sons, 2009. Print. Morrison, George R.. Liquidity preferences of commercial banks,. Chicago: University of Chicago Press, 2010. Print. Narusis, Romanas. Liquidity risk. Odense: Syddansk Universitet, 2008. Print. Nicholas, James C.. State regulation/housing prices. New Brunswick, N.J.: Center for Urban Policy Research, 2012. Print. Reuvid, Jonathan. Managing business risk a practical guide to protecting your business. 2nd ed. London: Kogan Page, 2005. Print. Walsh, Carl E.. Monetary theory and policy. Cambridge, Mass.: MIT Press, 2008. Print. Willett, Thomas D.. International liquidity issues. Washington, D.C.: American Enterprise Institute for Public Policy Research, 2010. Print. Equity derivatives applications in risk management and investment. London: Risk Publications, 1997. Print. Read More