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PRMIA Exam 8006 Topic 1 Question 33 Discussion

Actual exam question for PRMIA's Exam I: Finance Theory, Financial Instruments, Financial Markets ? 2015 Edition exam
Question #: 33
Topic #: 1
[All Exam I: Finance Theory, Financial Instruments, Financial Markets ? 2015 Edition Questions]

Which of the following statements are true:

1. Cash markets tend to be more liquid than derivative markets

II. A higher credit risk is associated with lower liquidity in times of crises

III. A higher bid-ask spread indicates greater liquidity when compared to a lower bid-ask spread

IV. A higher normal market size indicates greater liquidity than a lower market size

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Suggested Answer: C

The existence of derivative markets actually drives liquidity out of cash markets into derivative markets. Derivative markets are far more liquid than cash markets. Therefore statement I is not correct.

In times of crises, instruments or financial products bearing greater credit risk lose liquidity rapidly. Therefore statement II is correct.

A higher bid-ask spread indicates lower liquidity, not greater liquidity. Therefore statement III is false.

Normal market size (NMS) refers the 'normal' transaction size for which a dealer's quote is valid. A higher NMS is associated with greater liquidity, therefore statement IV is correct.


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