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FRM Part II · FRM Exam Part II · Illiquid Assets

A pension fund holds 30% of its portfolio in private equity and real estate partnerships. During a market sell-off, public equity values fall sharply while the fund continues to owe capital calls to its private partnerships. Which risk is most directly described by this situation?

The situation is funding liquidity risk. Capital calls on private partnerships are contractual obligations that must be paid in cash, and if liquid assets have dropped in value in a sell-off, the fund may be forced to sell them cheaply to meet those calls.

  1. AFunding liquidity risk arising from unfunded commitments that must be met while liquid assets have lost valueCorrect
  2. BTracking error risk arising from benchmark mismatch
  3. CReinvestment risk arising from early bond redemptions
  4. DBasis risk arising from imperfect hedges

Explanation

Unfunded commitments are contractual cash demands that must be paid on call. When liquid assets fall in value, the fund may have to sell them at depressed prices to meet calls, which is funding liquidity risk. The other options describe different risks unrelated to capital calls.

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