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

A bank's investment policy statement lists objectives of liquidity, income, and risk diversification. The ALCO notes that during a stress event the bank had to sell high-quality securities at a loss to meet deposit outflows, even though the securities were classified as held for investment income. Which conclusion is most consistent with the role of the investment function?

The portfolio's liquidity role was under-weighted. The policy should carve out a distinct buffer of readily marketable, unencumbered securities sized to stressed deposit outflows, so that liquidity needs do not force sales of income-oriented holdings at a loss.

  1. AThe income objective was correctly prioritised, and losses were unavoidable
  2. BLiquidity needs should have been met by the loan portfolio rather than securities
  3. CThe portfolio's liquidity role was under-weighted, so the policy should include a distinct liquidity buffer sized to stress outflowsCorrect
  4. DSecurities should be excluded from liquidity planning and treated only as an earnings asset

Explanation

Forced sales at a loss show the portfolio was not structured to meet stressed liquidity needs. A separate buffer of unencumbered, readily marketable assets sized to stressed outflows aligns the portfolio with its liquidity role. Loans are illiquid, so they cannot meet sudden outflows.

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