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

A fund manager notes that a tokenized bond embeds a smart contract that automatically pays coupons to current token holders on each payment date and enforces transfer restrictions to eligible investors only. Which statement best describes the main operational benefit and the associated risk of this programmability?

Programmability automates coupon payments and eligibility checks, lowering manual reconciliation and servicing work. The accompanying risk is smart contract risk, since a coding flaw executes automatically and may be hard to reverse. It does not remove issuer credit risk or the need for legal documentation.

  1. AIt reduces manual reconciliation and servicing steps, but code errors or bugs can execute incorrectly and automaticallyCorrect
  2. BIt eliminates all counterparty risk because payments are guaranteed by the code
  3. CIt removes the need for any legal documentation because the code is the contract
  4. DIt makes the token price independent of the issuer's credit quality

Explanation

Programmability automates servicing events such as coupon payments and compliance checks, cutting reconciliation and manual processing. The cost is smart contract risk: flawed code may execute erroneous actions automatically. Code does not guarantee that the issuer has the funds, does not replace legal enforceability, and does not remove credit exposure to the issuer.

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