Chartered Financial Analyst (CFA) Practice Exam Level 2

What is used to measure liquidity coverage?

1. Expected Cash Outflows / Highly Liquid Assets

2. Highly Liquid Assets / Expected Cash Outflows

3. Available Stable Funding / Required Stable Funding

4. Cash Inflows / Cash Outflows

The correct answer is: Highly Liquid Assets / Expected Cash Outflows

Measuring liquidity coverage involves assessing a financial institution's ability to meet its short-term obligations using its liquid assets. The correct choice indicates that the ratio is determined by dividing the amount of highly liquid assets by the expected cash outflows. This ratio is critical because it reflects how well a bank or financial institution can cover its projected cash outflows during a liquidity stress scenario. Highly liquid assets are those that can be quickly converted to cash without a significant loss in value, such as cash, government bonds, and other marketable securities. Expected cash outflows encompass the various anticipated demands for cash that a firm may face during a specified time frame, particularly in situations of financial stress. By evaluating the proportion of highly liquid assets to expected cash outflows, stakeholders can gauge the resilience of an institution in maintaining liquidity under adverse conditions. A higher ratio suggests a better positioning to withstand liquidity strains, while a lower ratio indicates potential vulnerability. Other choices focus on different financial aspects. For instance, the ratio of available stable funding to required stable funding relates to the stability of funding sources rather than short-term liquidity. The cash inflows to cash outflows metric offers a broader view of cash management but does not specifically measure liquidity coverage in the context usually referred to under regulatory frameworks