Skip to content

FRM Part II · FRM Exam Part II · Illiquid Assets

A hedge fund offers quarterly redemptions with a 90-day notice period and a gate limiting redemptions to 10% of fund NAV per quarter. During stress, investors request redemptions equal to 40% of NAV in one quarter. From a liquidity risk management perspective, what is the most important effect of the gate on remaining investors?

A gate lowers the chance of forced sales of illiquid assets at distressed prices, protecting remaining investors from dilution, but it can encourage investors to redeem early out of fear of being gated later. It does not remove the liquidity mismatch, it only slows its impact.

  1. AIt guarantees that remaining investors receive the same net asset value as redeeming investors on all positions
  2. BIt eliminates the fund's liquidity mismatch because assets and liabilities are then perfectly aligned
  3. CIt reduces the probability of a forced sale of illiquid assets at distressed prices, though it creates incentive for investors to redeem earlyCorrect
  4. DIt increases the fund's leverage because assets are retained while liabilities fall

Explanation

Gates slow outflows so the manager need not fire-sell illiquid positions, protecting remaining investors from dilution. However, they can create a first-mover/run incentive, since investors fear being gated later and so redeem early. They do not eliminate mismatch or raise leverage.

Did you get it right without looking?

One question tells you little. A timed set on Illiquid Assets shows your real accuracy, how long you take and where you lose marks.

Practise Illiquid AssetsFree diagnostic mock

More Illiquid Assets questions