The challenge of liquidity management is to maintain enough liquidity to avoid a crisis but to sacrifice no more earnings than absolutely necessary.

Question

BlackTom AI · Accepted Answer

The statement presents a viewpoint on liquidity management, highlighting two core objectives: maintaining enough liquidity to avoid a crisis and not sacrificing more earnings than necessary.

Option: True. This reflects mainstream financial management thinking, where firms aim to balance liquidity risk and opportunity cost. The first part acknowledges the importance of liquidity to prevent solvency or funding crises, ensuring that the firm can meet short-term obligations. The second part emphasizes minimizing the blot of liquid assets on earnings, recognizing that holding excess liquidity or converting assets to cash often incurs foregone returns. In practice, liquidity management seeks an optimal balance where the cost of holding liquidity is weighed against the risk and potential cost of illiquidity during stress periods.

Option: False. If we treat this option as a potential belief, it would imply that liquidity management should ignore earnings implications, or that liquidity should always be maximized regardless of cost. This is inconsistent with standard financial management, which emphasizes trade-offs between liquidity and profitability. Excessive liquidity can lead to a lower return on assets, while insufficient liquidity increases default risk and financing costs. Therefore, labeling the statement as false would contradict the well-established relationship between liquidity risk, crisis avoidance, and the opportunity costs of tying up funds.

In summary, the statement aligns with the fundamental trade-off concept in liquidity management, recognizing the dual aim of crisis avoidance and minimizing earnings sacrifice, whereas the alternative would ignore these essential trade-offs and is inconsistent with prudent financial practice.

FINS5530-Financial Institution Mgmt - T3 2025

The challenge of liquidity management is to maintain enough liquidity to avoid a crisis but to sacrifice no more earnings than absolutely necessary.

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