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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

A regulator wants to identify funds whose distress could threaten the wider financial system. Which feature of a hedge fund most directly raises its potential systemic importance?

High leverage with concentrated, illiquid positions and large dealer counterparty exposures makes a fund systemically important, because its distress can force fire sales and transmit losses to counterparties. Lock-ups, fee structures and past Sharpe ratios do not create such contagion channels.

  1. AHigh leverage combined with concentrated, illiquid positions and large counterparty exposures to major dealersCorrect
  2. BA high Sharpe ratio over the past five years
  3. CA long lock-up period for investors
  4. DCharging both management and incentive fees

Explanation

Systemic impact arises when forced deleveraging and fire sales propagate losses through counterparties and markets. Leverage, illiquidity, concentration and interconnectedness drive this. Lock-ups actually reduce redemption-driven forced selling, and fees or past Sharpe ratio say little about contagion.

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