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FRM Part II · FRM Exam Part II · Illiquid Assets

A risk manager at an endowment notes that during a market crisis, its listed real estate holdings fell sharply while its direct, appraisal-valued property holdings changed little. What is the most appropriate interpretation for risk reporting?

The direct property marks likely lag the market. Appraisal-based valuations are smoothed and slow to reflect crisis conditions, so reported risk is understated and delayed write-downs are probable, while listed real estate prices reveal the economic loss immediately.

  1. ADirect property is inherently less risky than listed real estate because its reported values fell less
  2. BThe direct property marks likely lag the market, so reported risk is understated and write-downs may follow laterCorrect
  3. CListed real estate is mispriced and should be valued using appraisals instead
  4. DAppraisal values reflect transaction prices, so no adjustment is needed

Explanation

Appraisals rely on lagged comparable sales and are smoothed, so they react slowly in crises and later catch up. The stability reflects valuation method, not lower economic risk. Treating the lower reported drop as lower risk is the main error.

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