Bank Alpha is making a decision about lending 10-year loans in a sector that is fairly illiquid. This type of lending requires stable and long-term funding sources to match the loan duration and illiquidity. Among the options provided:
* Overnight interbank markets: This option involves very short-term borrowing which needs to be rolled over frequently. The liquidity risk is high because the market conditions can change daily, making it the most exogenous liquidity risk as the availability and cost of funds can vary widely and unpredictably.
* The 6-month LIBOR markets: This is a short to medium-term funding option, still involving some liquidity risk due to the need for periodic refinancing, but less frequent than overnight markets.
* The 1-year treasury markets: Treasury markets are generally more stable and have lower liquidity risk compared to interbank markets. However, they still require annual refinancing.
* Foreign exchange markets: These markets add the complexity of currency risk along with liquidity risk.
Thus, overnight interbank markets exhibit the most exogenous liquidity risk due to the need for daily refinancing.References: How Finance Works, relevant pages discussing liquidity risks associated with different funding options.