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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

A bank's trading desk holds a large inventory of corporate bonds. A compliance officer must judge whether the desk's activity falls within the Volcker Rule market-making exemption. Which observation most strongly indicates the activity is proprietary trading rather than market making?

Positions far exceeding reasonable near-term client demand, with revenue driven mainly by price appreciation rather than spreads and fees, indicate proprietary trading. Market making is characterized by inventory sized to client demand, two-sided quotes and spread-based revenue, so the other observations are consistent with the exemption.

  1. AInventory levels are sized to reasonable expected near-term client demand based on historical patterns
  2. BThe desk earns revenue mainly from bid-ask spreads and fees
  3. CPositions are held far beyond expected client demand, and revenue derives mostly from price appreciation of the inventory rather than spreadsCorrect
  4. DThe desk posts two-sided quotes in the bonds it holds

Explanation

The exemption requires inventory to be designed not to exceed reasonable near-term client demand, with revenue primarily from spreads and fees rather than appreciation. Holding positions beyond expected demand and earning mainly from price gains signals proprietary speculation. The other options are consistent with market making.

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