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FRM Part II · FRM Exam Part II · Illiquid Assets

A fund of funds offers quarterly redemptions to its investors but invests mainly in private credit vehicles with multi-year terms. Which feature of this structure creates the greatest risk of a run-like dynamic among investors in stress?

The liquidity mismatch between quarterly redemption rights and illiquid multi-year private credit assets creates run risk. Early redeemers get cash at stated values, leaving remaining investors with a less liquid pool, which gives investors an incentive to redeem first in stress.

  1. ALiquidity mismatch between the redemption terms offered to investors and the liquidity of the underlying assetsCorrect
  2. BDiversification across many private credit managers
  3. CUse of a long-term investment horizon by the underlying managers
  4. DCharging performance fees only above a hurdle rate

Explanation

Offering frequent redemptions against illiquid assets creates a first-mover advantage: investors who redeem early receive cash at stated values while remaining investors bear the cost of selling illiquid assets. Diversification, long horizons and hurdle-based fees do not create this dynamic.

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