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FRM Part II · FRM Exam Part II · Liquidity Risk Management

During a crisis, a bank's CFP assumes it can sell a large block of asset-backed securities at near-market prices within a week to cover a funding gap. A risk manager objects. Which concern is most consistent with lessons from the crisis?

The risk manager's concern is the interaction of market and funding liquidity: if many firms sell at once, prices fall and haircuts rise, so proceeds are lower than assumed. This liquidity spiral makes the plan's sale assumption unreliable in stress.

  1. AMarket liquidity and funding liquidity interact, so asset sales by many institutions can depress prices and the realized proceeds fall short of assumptionsCorrect
  2. BAsset sales always raise funding liquidity without affecting prices
  3. CAsset-backed securities are treated as the highest quality liquid assets in all stress periods
  4. DSales proceeds are irrelevant to a funding gap if the bank is solvent

Explanation

Crisis experience showed a liquidity spiral: funding pressure forces sales, prices fall, haircuts rise and further funding is lost. Assuming market-price sales ignores this interaction. Other options deny price impact or misclassify the assets.

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