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FRM Part II · FRM Exam Part II · Contingency Funding Planning

During a combined stress, a bank's CFP model assumes that the bank can monetize a USD 500 million corporate bond portfolio at a 20% haircut on day 5. A reviewer notes that, in the scenario, many peer banks are also selling similar bonds and the bank's rating is downgraded. Which adjustment to the model is most appropriate?

The model should raise haircuts, lengthen the time needed to sell or repo the bonds, and reflect reduced collateral eligibility. In a combined stress, crowded selling and the bank's downgrade reduce the amount and speed of liquidity raised, so normal-market assumptions overstate the buffer.

  1. AKeep the 20% haircut because it was calibrated to normal markets, and add the proceeds to the buffer
  2. BIncrease the haircut and extend the time to monetize, and consider reduced repo eligibility, to reflect market-wide illiquidity and wrong-way effectsCorrect
  3. CRemove the haircut, since a downgrade of the bank does not affect the value of the assets it holds
  4. DReplace the portfolio by an equal amount of unsecured interbank borrowing in the model

Explanation

In a combined stress, asset market liquidity and funding liquidity interact: crowded selling widens haircuts and delays sales, and a downgrade can reduce collateral eligibility and counterparty appetite. The model should therefore use higher haircuts and slower monetization. Keeping normal-market calibrations overstates the buffer, and unsecured interbank funding is typically unavailable in such a stress.

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