Market liquidity refers to the ease with which an asset can be bought or sold without affecting its price.
Which of the following factors is most likely to increase the market liquidity of a fixed income security?
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A) A wider bid-ask spread indicates lower liquidity, as buying or selling the security is more difficult without affecting its price. B) Lower trading volume indicates lower liquidity, as fewer market transactions occur. C) The presence of market makers helps to maintain liquidity by actively quoting both buy and sell prices for a security. D) Higher interest rate risk may make a security less attractive to investors, potentially reducing liquidity.
What is the primary difference between the primary market and the secondary market for fixed income securities?
A) The primary market is where new securities are issued and sold to investors, while the secondary market is where previously issued securities are bought and sold among investors. B) The liquidity of the primary and secondary markets can vary depending on the specific security and market conditions. C) Both the primary and secondary markets can be open to various types of investors, depending on the specific security and offering. D) Both the primary and secondary markets are subject to regulation by the SEC and other regulatory bodies.
In the 2008 financial crisis, the market for mortgage-backed securities became highly illiquid as investors became increasingly concerned about the credit quality of the underlying mortgages. This lack of liquidity made it difficult for investors to sell their holdings, leading to significant losses and the crisis's overall severity.
Which of the following is an example of an illiquid fixed income security?
A) A U.S. Treasury bond with a high trading volume is likely to be highly liquid, as many transactions occur in the market. B) A corporate bond with a narrow bid-ask spread is likely highly liquid, as it is easier to buy or sell the security without affecting its price. C) A municipal bond issued by a small town with few interested buyers is likely illiquid, as fewer investors may be willing to buy or sell the bond, resulting in a wider bid-ask spread and potentially higher transaction costs. D) A mortgage-backed security with many market makers is likely to be highly liquid, as the market makers help maintain liquidity by actively quoting both buy and sell prices for the security.
A municipal bond issued by a small town may have lower market liquidity than a similar bond issued by a large city. This is because fewer investors may be interested in purchasing the small town's bond, resulting in a wider bid-ask spread and potentially higher transaction costs for investors looking to buy or sell the bond.
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Example Series 65 Example Practice Question
- *Market Liquidity*: Market liquidity refers to the ease with which an asset can be bought or sold in the market without significantly affecting its price. In the context of fixed-income securities, market liquidity is important because it affects the ability of investors to buy or sell bonds quickly and at a fair price.
- *High Market Liquidity*: A highly liquid bond market would have many buyers and sellers, and transactions can be completed quickly and easily. For example, U.S. Treasury bonds are considered to have high market liquidity because they are widely traded and easily bought or sold. - *Low Market Liquidity*: A less liquid bond market would have fewer buyers and sellers, and transactions may take longer to complete or result in larger price changes. For example, certain municipal bonds or corporate bonds may have lower market liquidity due to fewer market participants or less frequent trading.