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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A bank's investment policy sets objectives of liquidity, income and risk control. A portfolio manager proposes buying a high-yield, thinly traded bond to boost income. Which consideration most directly conflicts with the portfolio's liquidity objective?

The key conflict is that a thinly traded bond may not be sellable quickly without a large price concession during stress. The portfolio's liquidity objective requires assets that convert to cash promptly at little loss, so the higher coupon does not offset this weakness.

  1. AThe bond's coupon is above the portfolio average
  2. BThe bond cannot be sold quickly without a large price concession in stressCorrect
  3. CThe bond is denominated in the bank's home currency
  4. DThe bond has a fixed maturity date

Explanation

Liquidity requires assets convertible to cash quickly at little loss. A thinly traded bond may need a deep discount in stress, undermining that objective, whereas a high coupon, home currency and fixed maturity are not liquidity conflicts.

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