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FRM Part II · FRM Exam Part II · Illiquid Assets

An institutional investor is assessing liquidity risk in a portfolio of private equity fund commitments with large unfunded commitments. Which risk is most directly captured by the unfunded commitment, and how should it be managed?

Unfunded commitments create funding liquidity risk because general partners can call capital at short notice, often during market stress. Investors manage this by holding liquid reserves, modelling call patterns, or arranging committed credit lines, so they avoid forced sales of other assets to meet capital calls.

  1. AValuation smoothing risk, managed by using daily marks
  2. BFunding liquidity risk from capital calls, managed by keeping liquid reserves or a credit facilityCorrect
  3. CBasis risk, managed by hedging with equity index futures
  4. DReinvestment risk, managed by shortening fund lives

Explanation

Unfunded commitments are legally binding obligations that can be called on short notice, often when public markets are stressed. The investor must be able to meet calls without forced sales of other assets, so it holds liquid reserves or committed facilities.

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