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FRM Part II · FRM Exam Part II · Private Markets Investing

A pension fund holds a limited partner (LP) interest in a buyout fund. The fund has an unfunded commitment of $20 million that the general partner may call at short notice. Which risk does this unfunded commitment most directly create for the LP?

The unfunded commitment creates funding liquidity risk. The LP is legally obliged to provide cash when the general partner issues a capital call, so it must hold enough liquid resources or credit access to pay on short notice, or risk forced asset sales or default penalties.

  1. AFunding liquidity risk, because the LP must be able to meet capital calls when they are madeCorrect
  2. BBasis risk, because the fund's returns may differ from its benchmark
  3. CSurvivorship bias, because only successful funds report commitments
  4. DReinvestment risk, because distributions are always paid in kind

Explanation

An unfunded commitment is a legally binding obligation to supply cash on demand. The LP therefore faces the risk of being unable to fund calls without selling assets at poor prices or defaulting. Basis risk and survivorship bias concern benchmarking and data, not the call obligation.

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