What is the intuition behind cost of liquidation when a position is marked at mid but sold at bid?

Question

AcadiFi · Accepted Answer

The clean intuition is that your books may value a position at a fair mid-market price, but actual liquidation happens at executable prices. If you are long an asset and need to sell it quickly, you usually hit the bid, not the mid. That gap is the first piece of liquidation cost. If the position is large or the market is thin, market impact can widen the cost further.

Suppose Meridian Trading Warehouse carries a bond position at a mid price of 101.20. The current bid is 100.80. On the books, the position looks like it is worth mid. If the desk must unwind immediately, however, execution starts closer to bid. On a notional of $8 million, that 0.40 point gap already creates a meaningful realized drag before any additional slippage.

```mermaid
flowchart LR
  A[Book value at mid] --> B[Need to unwind]
  B --> C[Trade executes near bid]
  C --> D[Spread plus impact create liquidation cost]
```

The exam takeaway is that liquidation cost is not a mysterious extra fee. It reflects the difference between a reference valuation and an executable exit price under actual market conditions. Once you anchor on that, the logic becomes much easier to trust. Practice more in our FRM question bank.

What is the intuition behind cost of liquidation when a position is marked at mid but sold at bid?

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