Question: Sue Ellicott supervises the trading function at an asset management firm. In conducting an in-house risk management training session for traders, Ellicott elicits the following

Sue Ellicott supervises the trading function at an asset management firm. In conducting an in-house risk management training session for traders, Ellicott elicits the following statements from traders:

Trader 1. Liquidity risk is not a major concern for buyers of a security as opposed to sellers.

Trader 2: In general, derivatives can be used to substantially reduce the liquidity risk of a security.

Ellicott and the traders then discuss two recent cases of a similar risk exposure in an identical situation that one trader (Trader A) hedged and another trader (Trader B) assumed as a speculation. A participant in the discussion makes the following statement concerning the contrasting treatment:

Trader 3: Our traders have considerable experience and expertise in analyzing the risk, and this risk is related to our business. Trader B was justified in speculating on the risk within the limits of his risk allocation.

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