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

A bank's investment portfolio manager wants to raise portfolio yield by shifting from Level 1 government securities into lower-rated corporate bonds that do not qualify as HQLA. Which consequence is most directly relevant to the bank's liquidity risk management?

Replacing Level 1 sovereigns with non-qualifying corporate bonds reduces the HQLA buffer and can lower the LCR, because those bonds are harder to sell or repo in stress. The extra yield compensates for credit and liquidity risk and weakens the bank's contingency liquidity position.

  1. AThe bank's liquidity buffer and LCR may fall because the new holdings are less able to be monetised in stressCorrect
  2. BThe bank's required stable funding falls because corporate bonds have lower weights than sovereigns
  3. CThe bank's LCR rises because higher-yielding assets generate more inflows
  4. DThe bank's interest rate risk is eliminated because corporate bonds are floating-rate by nature

Explanation

Non-HQLA bonds receive no credit in the LCR numerator and may be hard to sell or repo at reasonable prices in stress, so the buffer shrinks. Higher yield is compensation for credit and liquidity risk, not a liquidity benefit. Corporate bonds do not carry lower NSFR weights than sovereigns, and they are not inherently floating-rate.

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