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FRM Part II · FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

A treasurer compares two funding mixes for a USD 600 million need. Mix X uses 100% three-month commercial paper. Mix Y uses USD 200 million three-month paper, USD 200 million one-year term debt and USD 200 million five-year senior bonds. Assuming equal spreads, which statement best describes the liquidity-risk trade-off?

Mix Y lowers rollover risk by laddering maturities, since only a third of funding matures within three months versus all of it in Mix X. The cost is typically higher interest when the yield curve slopes upward, so diversification of maturities trades cost for stability.

  1. AMix Y reduces rollover concentration by laddering maturities, but typically costs more if the yield curve is upward slopingCorrect
  2. BMix X has lower refinancing risk because short-term paper reprices more often
  3. CMix Y has higher rollover risk because it has more instruments
  4. DMix X and Mix Y have identical liquidity risk because total funding is equal

Explanation

Laddering spreads refinancing dates so only one-third of funding rolls within three months in Mix Y, versus all in Mix X. With an upward-sloping curve, longer funding carries higher rates. Mix X's frequent repricing is a rate benefit but increases refinancing risk.

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