Skip to content

FRM Part II · FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

A bank's liquidity manager is reviewing its collateral strategy. The bank currently pledges its highest-quality liquid sovereign bonds to cover routine intraday payment-system exposures, while lower-quality assets sit unused. During a stress event, the bank needs to raise cash quickly in the repo market. Which is the most appropriate criticism of the current approach?

Using the most liquid sovereigns for routine intraday needs encumbers assets that are most valuable in stress, reducing the buffer available for repo funding. Better practice allocates cheapest-to-deliver acceptable collateral to routine uses and preserves high-quality assets for stress.

  1. AUsing the most liquid assets for routine needs can deplete the pool of assets most readily convertible to cash under stress, so the bank should allocate collateral on a cheapest-to-deliver basis where feasibleCorrect
  2. BPledging high-quality assets eliminates the need for any contingency funding plan
  3. CLower-quality assets should always be sold first because they carry no haircut
  4. DThe approach is optimal because sovereign bonds never lose value in stress

Explanation

Encumbering the best assets for routine needs reduces the unencumbered liquid buffer available in stress. Efficient collateral management allocates the least liquid acceptable asset to each use. Lower-quality assets carry larger haircuts, not none, and a contingency plan is still required.

Did you get it right without looking?

One question tells you little. A timed set on Liquidity and Reserves Management: Strategies and Policies shows your real accuracy, how long you take and where you lose marks.

Practise Liquidity and Reserves Management: Strategies and PoliciesFree diagnostic mock

More Liquidity and Reserves Management: Strategies and Policies questions