FRM Part II · FRM Exam Part II · Liquidity Risk
A bank's treasury team is designing a liquidity stress test. Which design choice best reflects sound practice for a severe but plausible combined scenario?
The best design combines an idiosyncratic shock with a market-wide shock and tests several time horizons. Liquidity stress unfolds over time and different funding sources run at different speeds, so single-day, asset-only, or uniform-outflow tests understate the true stress.
- ACombine an idiosyncratic shock, such as a rating downgrade, with a market-wide shock, and run it over multiple time horizonsCorrect
- BModel only a single-day deposit outflow at average historical rates
- CStress only the asset side, since liabilities are contractually fixed
- DApply the same outflow rates to every funding source regardless of counterparty type
Explanation
Sound liquidity stress tests combine idiosyncratic and market-wide shocks and examine several horizons, because liquidity stress evolves over time. Average outflow rates understate stress, ignoring liabilities misses run risk, and uniform rates ignore that wholesale and insured retail funds behave differently.
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