Chartered Financial Analyst (CFA) Practice Exam Level 2

Which of the following represents expected cash outflows in liquidity coverage?

1. Total Assets

2. Highly Liquid Assets

3. Common Stock

4. Cash Receipts from Customers

The correct answer is: Highly Liquid Assets

The correct choice reflects the concept of liquidity coverage, which is a vital part of financial management, particularly in ensuring that an institution can meet its short-term obligations. The Liquidity Coverage Ratio (LCR) is designed to ensure that a financial institution has an adequate stock of unencumbered liquid assets that can be quickly converted to cash to meet its liquidity needs for a specific stress scenario. Highly liquid assets are defined as assets that can be converted into cash with minimal loss of value, typically including cash, marketable securities, and other instruments deemed liquid by regulators. In a liquidity coverage context, these assets are critical because they provide the necessary cushion against potential cash outflows during times of financial stress. In contrast, total assets encompass all assets of an organization, whether they are liquid or not, and do not specifically represent liquidity levels. Common stock represents equity rather than a means to cover cash outflows. Cash receipts from customers, while relevant for cash inflow analysis, do not represent anticipated cash outflows, which are essential in assessing liquidity needs. Therefore, focusing on highly liquid assets is fundamental for ensuring sufficient coverage to manage expected cash outflows effectively during financial uncertainties.