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

A bank funds a portfolio of ten-year fixed-rate loans. The treasurer is deciding between issuing ten-year fixed-rate senior debt and rolling a series of one-year large time deposits. Which is the principal liquidity advantage of the long-term debt?

Long-term debt reduces rollover risk because funding is locked in for roughly the life of the assets. The tradeoff is typically a higher cost when the yield curve slopes upward, since investors demand a term premium, so it is not free or fully risk-eliminating.

  1. AIt eliminates interest-rate risk on the bank's entire balance sheet
  2. BIt lowers rollover risk by locking in funding for the asset horizon, although it typically costs more than short-term funding in an upward-sloping curveCorrect
  3. CIt always has a lower coupon than one-year deposits, because longer maturities carry less credit risk
  4. DIt can be redeemed by the bank at no cost at any time, without penalty

Explanation

Term debt matches funding tenor to asset tenor, removing refinancing risk over the horizon. With an upward-sloping curve and a term premium, the cost is usually higher than short-term funding. Option 0 is overstated; option 2 reverses the usual term premium logic; option 3 ignores call or buyback costs.

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