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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

In September 2008, a large money market mutual fund 'broke the buck' after writing off its holdings of debt issued by a collapsed investment bank. Which immediate consequence best describes the effect on short-term funding markets?

Redemptions surged from prime money market funds after one broke the buck, which cut their purchases of commercial paper and other short-term debt. This tightened short-term funding for banks and corporations, worsening the liquidity crisis in September 2008.

  1. AInvestors rushed to redeem from prime money market funds, reducing demand for commercial paper and tightening short-term fundingCorrect
  2. BDemand for commercial paper rose sharply as funds sought higher yields
  3. CRepo haircuts on Treasury collateral fell across the market
  4. DInterbank lending spreads narrowed as confidence returned

Explanation

The fund's net asset value fell below $1 per share, shattering the perception that money funds were safe. Investors redeemed heavily, and since these funds were major buyers of commercial paper, issuers faced a funding squeeze. The other options describe easing conditions, which did not occur.

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