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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

A supervisor assesses how investor composition affects the amplification of geopolitical shocks. Which feature would most likely increase the amplification of portfolio outflows during a shock?

Open-end funds offering daily liquidity while holding relatively illiquid assets amplify shocks. The liquidity mismatch creates first-mover incentives to redeem, forcing fire sales that depress prices and trigger further redemptions, unlike long-horizon investors with stable funding, who tend to dampen outflows.

  1. AInvestors with long-term mandates and stable funding
  2. BOpen-end funds with daily liquidity investing in relatively illiquid assets, creating liquidity mismatchCorrect
  3. CInvestor base dominated by domestic pension funds with long liabilities
  4. DCapital controls that are fully credible and pre-announced

Explanation

Liquidity mismatch between daily redemption rights and illiquid holdings gives investors a first-mover incentive to redeem, forcing asset sales that depress prices and amplify outflows. Long-term stable investors and long-liability pensions dampen outflows. Credible controls restrict flows rather than amplify them.

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