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

A bank's investment policy states that securities held to satisfy the liquidity buffer must be unencumbered and readily convertible to cash with little loss of value. A portfolio manager proposes adding a thinly traded, lower-rated corporate bond with a higher yield to this buffer. What is the most appropriate response under a sound investment policy?

The bond should be rejected for the liquidity buffer because it is thinly traded and lower-rated, failing the policy's quality and liquidity criteria. Higher yield does not justify it there, though it could be held in the investment portfolio within approved limits.

  1. AApprove it, because higher yield compensates for liquidity risk in the buffer
  2. BReject it for the buffer, because it fails the policy's liquidity and quality criteria, though it may be considered for the non-buffer investment portfolio within limitsCorrect
  3. CApprove it if the bond is pledged in repo markets to raise cash
  4. DApprove it if the portfolio's average maturity stays below one year

Explanation

The buffer's purpose is dependable liquidity, so yield cannot offset failing eligibility criteria. Pledging the bond would encumber it, and average maturity does not fix the individual asset's marketability. The bond may still fit the return-oriented portfolio within limits.

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