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

A treasurer compares two funding plans for a USD 500 million need. Plan 1 uses 3-month paper rolled four times over the year. Plan 2 uses a 1-year term issue at a higher spread. Which statement best describes the trade-off from a liquidity risk perspective?

Plan 2 reduces rollover risk because the funding is locked in for the full year, but it costs more through a higher spread. Plan 1 is cheaper yet must be refinanced four times, exposing the bank to market closure or repricing in stress.

  1. APlan 1 has lower rollover risk because it is repriced more often
  2. BPlan 2 reduces rollover risk and locks in funding, at the cost of higher expected funding costCorrect
  3. CBoth plans have identical liquidity risk because the amount borrowed is the same
  4. DPlan 1 eliminates refinancing risk since short-term paper is always liquid

Explanation

Term funding removes the need to refinance during the year, lowering rollover risk, but typically costs a term premium. Short-term paper is cheaper but must be refinanced repeatedly and may be unavailable in stress.

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