Practice Quiz

FRM Financial Risk Manager Practice Test

Category - Terms and concepts

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A liquidity trap is...
  1. A strategy that an investor would use to gain his competitor’s liquid assets.
  2. A situation where the liquidity in the market created by low interest rates does not stimulate the economy to full employment.
  3. A strategy that banks use to trap house owners to pay their mortgages.
  4. A situation when liquid assets become illiquid because they are unable to be sold or bought.
Explanation
A liquidity trap describes the situation where the liquidity in the market created by low interest rates does not stimulate the economy to full employment.

Key Takeaway: The nominal interest rate cannot drop below zero. Any further injection of liquidity will not further lower the nominal interest rate.
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