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FRM Part II · FRM Exam Part II · Liquidity Risk Reporting and Stress Testing

Supervisors reviewing a bank's liquidity stress testing find that every scenario assumes the bank can sell its large corporate bond portfolio at market prices within a day. Which weakness is most directly indicated?

The weakness is inadequate treatment of market liquidity. In stress, large bond holdings cannot normally be sold at prevailing prices within a day, so haircuts, price impact and longer liquidation times must be reflected in the scenario assumptions.

  1. AInadequate treatment of market liquidity and asset haircuts under stressCorrect
  2. BExcessive conservatism in deposit runoff assumptions
  3. COverreliance on intraday liquidity monitoring
  4. DFailure to use a one-year horizon for capital planning

Explanation

Under stress, market liquidity deteriorates and haircuts and time-to-sell lengthen, so assuming full-price sale within a day ignores asset liquidity risk. The other options do not describe the assumption given.

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