FRM Part II · FRM Exam Part II · Illiquid Assets
A family office is designing a portfolio with a large allocation to illiquid assets. Which action best addresses the risk that capital calls coincide with falling liquid asset values (the denominator effect and funding squeeze)?
Maintain a dedicated liquidity reserve and stress-test unfunded commitments against simultaneous declines in liquid assets. Secondary sales at par cannot be assumed in stress, and concentrating vintages raises timing risk rather than reducing it.
- AHold a dedicated liquidity reserve and stress-test unfunded commitments against market declinesCorrect
- BRaise the allocation to illiquid assets since their reported volatility is low
- CRely on selling illiquid fund interests in the secondary market at par during stress
- DCommit only to a single vintage year to simplify cash planning
Explanation
A liquidity buffer sized by stress tests of commitments and market declines addresses the correlation of calls with falling liquid values. Secondary sales usually occur at discounts in stress, and a single vintage concentrates rather than diversifies timing risk.
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