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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A bank funds a large share of its balance sheet with 30-day commercial paper and relies on a committed backup line for rollover. Money market conditions deteriorate and the issuer's short-term rating is downgraded below the top tier. Which is the most appropriate liquidity risk conclusion?

A downgrade raises rollover risk, because CP investors with rating limits may stop buying or demand wider spreads. The bank would then depend on its backup line, which itself may be strained or conditional, so contingency funding planning remains essential despite the short maturity.

  1. ARollover risk has risen because investors may refuse to refinance or demand higher spreads, so the backup line becomes a critical, possibly stressed, source of liquidityCorrect
  2. BRisk is unchanged because the CP matures within 30 days
  3. CRisk has fallen because shorter maturities reduce interest rate exposure
  4. DRisk is eliminated since a committed line exists, so no contingency planning is needed

Explanation

A downgrade narrows the investor base for CP, especially money market funds with rating-based limits, raising rollover risk. The backup line may be drawn heavily and can contain conditions or be drawn by many borrowers at once. Short maturity increases, not reduces, refinancing frequency.

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