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FRM Part I · FRM Exam Part I · Fund Management

An open-end fund holds illiquid bonds and faces heavy redemptions during a market stress. Which statement best explains why open-end structures create greater liquidity risk than closed-end structures for such a portfolio?

Open-end funds must meet redemptions at NAV, so heavy outflows force asset sales, possibly at depressed prices for illiquid holdings. This can hurt remaining shareholders. Closed-end funds have a fixed share count traded on exchanges, so investors exit by selling shares to other investors, not by forcing the fund to liquidate.

  1. AOpen-end funds must sell assets, possibly at depressed prices, to meet redemptions at NAV, which can disadvantage remaining shareholdersCorrect
  2. BClosed-end funds must redeem shares at NAV on demand, forcing asset sales
  3. COpen-end funds trade at a discount to NAV, so redemptions are paid at market price
  4. DOpen-end fund NAV is set by exchange supply and demand, so redemptions do not require asset sales

Explanation

Open-end investors redeem at NAV, so the fund must raise cash, often selling the most liquid assets first or selling at distressed prices, leaving remaining investors with a less liquid, lower-value pool. Closed-end funds do not redeem shares. Open-end funds are priced at NAV, not exchange prices.

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