Skip to content

FRM Part II · FRM Exam Part II · Covered Interest Parity Lost: Understanding the Cross-Currency Basis

A bank's liquidity risk committee reviews its USD funding profile. It has USD 20 billion of USD assets funded by USD 6 billion of USD deposits, USD 4 billion of long-term USD debt, and USD 10 billion of FX swaps with an average maturity of one month. Which treasury response most directly mitigates the vulnerability to a dollar shortage episode?

The bank should diversify toward stable USD deposits and longer-term USD debt, lengthen swap tenors, and hold a USD liquidity buffer. With half of USD funding in one-month swaps, rollover risk during a dollar shortage is the main vulnerability.

  1. AIncrease the share of USD funding from long-term debt and stable deposits and lengthen the swap maturities, while holding a USD liquidity bufferCorrect
  2. BReplace the FX swaps with unhedged EUR borrowing to avoid the basis
  3. CShorten the swap maturities to reduce exposure to the basis
  4. DReduce USD liquid assets to cut carrying cost of the buffer

Explanation

Half of USD funding is one-month swaps, so the bank faces heavy rollover risk when the basis widens. Lengthening tenor, adding stable USD funding, and holding a buffer reduce that risk. Unhedged borrowing adds FX risk, shortening swaps raises rollover frequency, and cutting liquid assets weakens resilience.

Did you get it right without looking?

One question tells you little. A timed set on Covered Interest Parity Lost: Understanding the Cross-Currency Basis shows your real accuracy, how long you take and where you lose marks.

Practise Covered Interest Parity Lost: Understanding the Cross-Currency BasisFree diagnostic mock

More Covered Interest Parity Lost: Understanding the Cross-Currency Basis questions