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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A treasurer must choose between two investments for a liquidity buffer. Asset X is a 10-year sovereign bond that is HQLA eligible, yielding 3.0%. Asset Y is a 10-year unrated corporate bond not HQLA eligible, yielding 4.2%. Which statement best captures the trade-off from a liquidity-risk perspective?

Asset X is preferable for the liquidity buffer because it can reliably be turned into cash in stress and counts as HQLA, even though it gives up 1.2% of yield. Yield compensation does not substitute for monetizability or regulatory eligibility.

  1. AAsset Y adds more to the buffer because its higher yield compensates for any stress haircut
  2. BAsset X is preferable for the buffer because its value is reliably monetizable in stress, even though it sacrifices 1.2% of yieldCorrect
  3. CBoth assets count equally toward regulatory liquidity requirements because maturities are identical
  4. DAsset Y is preferable because non-HQLA assets are exempt from market liquidity risk

Explanation

Buffer assets are valued for their reliable convertibility to cash under stress, not for yield. The 1.2% yield give-up is the cost of that liquidity. Option A confuses yield with liquidity, C ignores eligibility criteria, and D is false since non-HQLA assets carry greater market liquidity risk.

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