Skip to content

FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust

A central bank raises its policy rate sharply to bring down inflation. A risk manager at a bank with a large portfolio of long-dated fixed-rate government bonds funded by short-term wholesale deposits is assessing the main financial stability channel of this tightening. Which channel is most directly relevant to the bank?

The key channel is valuation losses on long-dated fixed-rate bonds together with faster-rising short-term funding costs. Bond prices fall when yields rise, while wholesale deposits reprice quickly, so the bank's capital and liquidity are squeezed by the duration and maturity mismatch.

  1. AMark-to-market losses on the bond portfolio combined with rising funding costs, which squeeze capital and liquidityCorrect
  2. BHigher policy rates raise the market value of fixed-rate bonds, strengthening capital
  3. CTighter policy lowers short-term funding costs because deposit rates fall faster than bond yields
  4. DHigher rates eliminate duration risk because coupons are reset immediately

Explanation

Rising rates reduce the price of long-dated fixed-rate bonds while short-term wholesale funding reprices quickly, creating a duration and maturity mismatch. This hurts capital through valuation losses and strains liquidity. The option claiming bond values rise has the price-yield relationship reversed.

Did you get it right without looking?

One question tells you little. A timed set on Monetary and Fiscal Policy: Safeguarding Stability and Trust shows your real accuracy, how long you take and where you lose marks.

Practise Monetary and Fiscal Policy: Safeguarding Stability and TrustFree diagnostic mock

More Monetary and Fiscal Policy: Safeguarding Stability and Trust questions