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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

A fund manager is reviewing how hedge funds could contribute to systemic risk. Which of the following mechanisms is most commonly cited as a channel through which hedge funds may transmit or amplify systemic stress?

Hedge funds are most commonly linked to systemic risk through forced deleveraging. When lenders raise margins or cut funding, leveraged funds must sell assets quickly, which pushes prices down, spreads losses to other holders and counterparties, and can amplify market stress.

  1. AForced deleveraging and fire sales by highly leveraged funds when lenders raise margin requirementsCorrect
  2. BTheir legal status as deposit-taking institutions covered by government guarantees
  3. CMandatory investment of fund assets in sovereign bonds only
  4. DTheir obligation to redeem investors at net asset value on a daily basis in all cases

Explanation

Leveraged funds that face higher margins or funding withdrawals must sell assets quickly, depressing prices and spreading losses to other holders and counterparties. Hedge funds do not take insured deposits, are not restricted to sovereign bonds, and daily redemption is not a universal obligation.

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