Which of the following is a measure of the potential losses an FI could suffer as the result of fire-sale disposal of assets?

Question

BlackTom AI · Accepted Answer

Liquidity index quantifies how much value a financial institution would lose if it had to sell assets quickly at distressed prices, so it directly measures potential fire-sale losses.

1) Relevant knowledge points and concepts
- Fire-sale disposal: forced rapid sale of assets that typically requires accepting discounted prices (price impact or haircuts).
- Liquidity index: a metric that combines asset marketability, typical bid–ask spreads, time-to-liquidate, and expected price impact to estimate potential loss from rapid disposal.
- Other liquidity measures (quick ratio, current ratio) and financing gap are short-term solvency/funding metrics or benchmarks, not direct measures of forced-sale price losses.

2) Step-by-step reasoning
- Identify the problem: fire sales create price discounts (haircuts) that reduce recovery value.
- A proper measure must estimate those discounts across the asset portfolio and aggregate them into an expected loss.
- Liquidity index is designed for that: it assigns liquidity scores or haircut percentages to asset classes (based on market depth, volatility, time to sell), multiplies each asset’s market value by its expected haircut, and sums the results to get total potential loss.

3) Calculations (conceptual intermediate steps)
- For each asset i: expected loss_i = market value_i × expected haircut_i.
- Liquidity index (total expected fire-sale loss) = Σ expected loss_i across all assets.
(There are no numeric inputs here; this shows the computational logic.)

4) Why the correct answer is correct
- The liquidity index explicitly targets market-liquidity-driven loss estimates under rapid disposal scenarios, so it measures the potential losses from fire sales.

5) Why other options are incorrect
- Quick ratio: measures short-term liquidity to meet liabilities using liquid assets, not market-loss from forced sales.
- Current ratio: broader short-term coverage of current liabilities, not fire-sale loss.
- Financing gap and financing requirement: measure funding mismatches and liquidity needs, not price discounts on asset disposal.
- Peer group ratio: a benchmarking/comparative metric, not an estimate of fire-sale losses.

6) Conclusion
- Therefore, the liquidity index (option e) is the correct measure of potential losses from fire-sale disposal, confirming the provided answer.

Which of the following is a measure of the potential losses an FI could suffer as the result of fire-sale disposal of assets?单项选择题

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