FRM Part II · FRM Exam Part II · Illiquid Assets
A pension fund's investment committee is reviewing its allocation to private real estate and infrastructure funds. A trustee argues that the fund should invest in illiquid assets mainly because they offer a liquidity premium. Which statement best describes the liquidity premium in this context?
The liquidity premium is the extra expected return investors earn for holding assets that cannot be sold quickly or cheaply. It compensates for trading costs and delay risk. It is not guaranteed, and it is unrelated to leverage, appraisal smoothing or fee rebates.
- AExtra expected return earned by investors who are willing to hold assets that cannot be sold quickly or cheaplyCorrect
- BA guaranteed excess return over listed equities that compensates for the use of leverage in private funds
- CThe reduction in reported volatility that results from appraisal-based valuation of private assets
- DThe fee rebate that general partners offer to investors who commit capital for the full fund term
Explanation
The liquidity premium is the additional expected return demanded for bearing the cost and delay of trading an asset. It is not guaranteed, and it is not a feature of smoothing or of fees. The smoothing option describes an artifact of reported returns, not compensation for illiquidity.
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