Question: What is the liquidity risk?
Answer: Liquidity risk is the risk that as an investor you will have to sell a bond below its true value.
Question: How can you measure the liquidity risk?
Answer: The primary measure of liquidity is the size of the spread between the bid price and the ask price quoted by a dealer. The wider the bid/ask spread, the greater is the liquidity risk.
Question: what do you mean by a liquid market?
Answer: Generally, a liquid market, can be defined by “small bid/ask spreads which do not materially increase for large transactions.� How to define the bid/ask spread in a multiple-dealer market is subject to interpretation. For example, consider the bid/ask spread for four dealers.
Question: How bid/ask spread is measured for a bond?
Answer: The bid/ask spread can be computed by looking at the best bid/high price for buy and the lowest ask/sell price. This liquidity measure is called the market bid/ask spread.