Liquidity risk can also be classified in to two parts.
Ø Assets Liquidity Risk
Ø Funding Liquidity Risk
Assets Liquidity Risk/ Market/ Product Liquidity Risk: It arises when a transaction cannot be conducted at prevailing market prices due to the size of the position related to normal trading lots. It can be managed by setting limits on certain markets or products and by means of diversification.
Funding Liquidity Risk: It is also known as cash flow risk, refer to the inability to meet payments obligations, which may force early liquidation, thus transforming paper losses in to realize losses. This especially a problem for portfolio that are leveraged and subject to margin calls from the lenders. Cash flow risk interacts with product liquidity risk if the portfolio contains illiquid assets that must be sold at less than fair market value.
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