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FRM Part II · FRM Exam Part II · Illiquid Assets

A endowment's investment committee is deciding how to treat its private equity holdings in a liquidity risk framework. Which characteristic of these assets is most important to incorporate when assessing liquidity risk?

The key liquidity risk is that capital calls are hard to predict while distributions are uncertain and tend to fall in stress, leaving unfunded commitments to be met when other assets are also falling. Private equity has no daily redemption, and reported NAV is not a guaranteed exit price.

  1. ACapital calls are unpredictable and distributions are uncertain, so the fund may face unfunded commitments during market stressCorrect
  2. BPrivate equity has daily redemption rights, so liquidity can be raised at short notice
  3. CPrivate equity valuations are market quotes, so liquidation value equals reported NAV
  4. DIlliquidity risk disappears if the holding period exceeds one year

Explanation

Investors in private funds have unfunded commitments that can be called at short notice while distributions tend to dry up in downturns, creating a liquidity squeeze. Redemption is generally not available, NAV is not a tradable price, and illiquidity does not vanish after a year.

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