All other things constant, securities that are extremely liquid:[Fill in the blank]

Question

BlackTom AI · Accepted Answer

High liquidity means an asset can be converted to cash quickly with little price concession, so it carries less liquidity risk.

1) Relevant knowledge points and concepts
- Liquidity: ability to buy or sell an asset quickly at a price close to its quoted market price.
- Liquidity risk: the risk that an investor cannot trade when desired or must accept a large price concession.
- Liquidity premium and risk-return tradeoff: less liquid assets typically require higher expected returns to compensate investors for bearing liquidity risk; more liquid assets therefore have lower required returns and lower liquidity-related risk.
- Bid–ask spreads, market depth and price impact: liquid assets have narrow spreads and deeper markets, reducing transaction cost volatility.

2) Step-by-step reasoning process
- “All other things constant” (ceteris paribus) isolates liquidity as the varying attribute.
- If an asset is extremely liquid, an investor can sell it quickly without moving the market price; this reduces the chance of large unexpected losses from forced sales.
- Reduced liquidity risk lowers the overall risk profile of the security, all else equal.
- Because investors demand compensation for bearing risk, less risky (more liquid) securities will not require higher return to attract buyers; instead they typically offer lower expected returns than less liquid alternatives.

3) Intermediate logical steps (no numeric calculations required)
- Liquidity ↓ risk of forced sale → lower probability of price concession.
- Lower liquidity risk → smaller liquidity premium demanded.
- Smaller premium → lower required/expected return relative to less liquid securities.

4) Why the correct answer is correct
Answer c states extremely liquid securities have lower risk than less liquid securities. This directly follows from liquidity reducing liquidity risk and transaction-cost-driven price volatility; therefore extremely liquid securities are less risky on that dimension, ceteris paribus.

5) Why other options are incorrect
- a (earn higher rates of return): incorrect because higher liquidity reduces required return; less liquid securities generally earn higher returns to compensate for liquidity risk.
- b (have a longer maturity): incorrect—liquidity is not synonymous with longer maturity; often shorter-maturity instruments (e.g., T-bills) are more liquid.
- d and e (combinations): incorrect because they include (a) or (b), which are wrong.

6) Conclusion
Therefore, under the ceteris paribus assumption, extremely liquid securities have lower risk than less liquid securities. This confirms answer c.

All other things constant, securities that are extremely liquid:[Fill in the blank]Single choice

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