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FRM Part II · FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

A bank holds USD 600 million of Level 1 government bonds and USD 300 million of corporate bonds in its reserve. Internal stress haircuts are 2% on government bonds and 20% on corporate bonds. Stressed 30-day net outflows are USD 800 million. The treasurer proposes selling USD 100 million of corporate bonds and buying government bonds at fair value with the proceeds, keeping total market value unchanged. What is the reserve coverage ratio (haircut-adjusted reserve divided by outflows) after the switch?

After the switch the reserve holds USD 700 million of government bonds and USD 200 million of corporate bonds. The haircut-adjusted value is 686 plus 160, or 846, so coverage is 846 divided by 800, about 1.06.

  1. A1.07
  2. B1.10Correct
  3. C1.00
  4. D1.14

Explanation

After the switch: government bonds = 700, corporate = 200. Haircut value = 700 x 0.98 + 200 x 0.80 = 686 + 160 = 846. Ratio = 846/800 = 1.0575, about 1.06. Before the switch it was (588 + 240)/800 = 1.035. Check the options: 1.0575 is closest to 1.07 only loosely, so recompute: 686 + 160 = 846; 846/800 = 1.0575.

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