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FRM Part II · FRM Exam Part II · Fundamental Review of the Trading Book

A regulator criticizes a bank's use of a 10-day horizon for all positions when computing VaR for trading book capital. Which FRTB design feature responds most directly to this criticism?

FRTB assigns each risk factor to a liquidity horizon, from 10 up to 120 days, and scales expected shortfall accordingly. This addresses the flawed assumption that all positions can be liquidated or hedged within ten days, an assumption that failed for illiquid instruments during the crisis.

  1. AApplying a 1-day horizon to every risk factor
  2. BAssigning risk factors to liquidity horizons ranging from 10 to 120 days to reflect market illiquidityCorrect
  3. CEliminating horizons by using only the standardized approach
  4. DUsing a 250-day horizon for all equity positions

Explanation

A uniform 10-day horizon assumed all positions could be hedged or liquidated in that time, which failed in the crisis for illiquid products. FRTB assigns risk factors to liquidity horizons of 10, 20, 40, 60 or 120 days, scaling the ES contributions accordingly. It does not use a single 1-day or 250-day horizon for all positions.

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