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

A treasurer wants to increase yield on the investment portfolio by shifting from short-term government securities into longer-maturity corporate bonds. Which trade-off is most accurate?

Shifting to longer corporate bonds should raise yield, but it increases price volatility, credit risk and liquidity risk in stressed markets. Accounting treatment does not remove these economic risks, so the treasurer is trading liquidity and safety for income.

  1. AYield is expected to rise, but market price volatility, credit risk and liquidity risk under stress also riseCorrect
  2. BYield rises with no change in risk because corporate bonds are accounted for at amortized cost
  3. CLiquidity improves because longer maturities mean fewer cash flows to manage
  4. DCredit risk falls because corporate bonds are diversified

Explanation

Moving to longer corporate paper typically gains a term and credit spread, but increases interest-rate sensitivity, credit exposure and the chance of wide bid-ask spreads in stress. Accounting classification does not remove economic risk.

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