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FRM Part II · FRM Exam Part II · Tokenization and Financial Market Inefficiencies

A broker-dealer finances a securities inventory of USD 500 million and must prefund trades because settlement takes T+2. Reconciliation across intermediaries requires holding extra liquidity buffers. Which statement best describes how such frictions create market inefficiency?

Settlement lags and multi-party reconciliation raise capital and liquidity costs and extend counterparty exposure between trade and settlement. Collateral and buffers are tied up that could be used elsewhere. This is the inefficiency tokenization seeks to reduce through faster, synchronized settlement.

  1. AThey raise the cost of capital and counterparty exposure during the settlement window, tying up collateral and liquidity that could otherwise be deployedCorrect
  2. BThey eliminate counterparty risk because settlement is delayed
  3. CThey increase transparency because more intermediaries verify each trade
  4. DThey lower transaction costs because intermediaries compete on fees

Explanation

Settlement lags create exposure between trade and settlement and require collateral, prefunding and buffers, which trap capital. More intermediaries add cost and reconciliation, not lower risk. Delay does not eliminate counterparty risk; it prolongs it.

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