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

A treasurer must decide how to size the liquidity reserve. Which approach is most consistent with good reserve management practice?

The reserve should be sized from stress-test projections of cash outflows and reviewed regularly as conditions and the business change. Fixed ratios, normal-day needs or last year's balances fail to capture stressed outflows and shifting funding profiles.

  1. ASet the reserve from stress-test outflow projections and review it as conditions and the business changeCorrect
  2. BSet the reserve at a fixed percentage of total assets and never revisit it
  3. CSize the reserve only to cover normal daily operations
  4. DBase the reserve on the prior year's average cash balance

Explanation

Good practice links reserve size to stressed cash-flow projections across scenarios and horizons, with regular review as the balance sheet, funding mix and market conditions change. Fixed ratios, normal-day needs or historical balances ignore stress behavior.

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