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

A bank issues 5-year senior unsecured notes to replace USD 300 million of overnight wholesale funding. Which is the primary liquidity benefit, and a corresponding cost, of this change?

Replacing overnight funding with 5-year notes lowers refinancing and rollover risk because the funding is locked in for longer. The trade-off is usually a higher interest cost, since investors require a term premium and credit spread for lending longer.

  1. ALower refinancing risk, but typically a higher interest cost because of the term premiumCorrect
  2. BHigher refinancing risk, but a lower interest cost because of the credit spread
  3. CElimination of all interest rate risk, at a cost of lower liquidity coverage
  4. DLower funding cost, because long-term debt always yields less than overnight funding

Explanation

Extending maturity removes the need to roll funding daily, reducing refinancing and run risk. Investors usually demand a term premium and credit spread, so the cost is usually higher than overnight rates in a normal upward-sloping curve. Option claiming lower cost ignores this premium.

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