Skip to content

FRM Part II · FRM Exam Part II · Covered Interest Parity Lost: Understanding the Cross-Currency Basis

Which action is most consistent with sound liquidity management for a non-US bank that relies heavily on FX swap markets for dollar funding and is concerned about a widening cross-currency basis?

The sound approach is to diversify dollar funding sources and maturities, maintain a buffer of unencumbered dollar liquid assets, and stress test for basis widening. This reduces rollover risk and dependence on FX swap markets, whereas overnight reliance or assuming central bank support would leave the bank exposed.

  1. ADiversify dollar funding sources and tenors, hold a buffer of unencumbered dollar liquid assets, and include basis widening in liquidity stress testsCorrect
  2. BRely exclusively on overnight FX swaps because they are the cheapest
  3. CAssume central bank swap lines will always be available and hold no dollar buffer
  4. DHedge the basis risk by lending more dollars at short maturities

Explanation

Diversification, a dollar liquidity buffer and stress testing address the rollover and cost risk from the basis. Overnight reliance increases rollover risk, and assuming central bank support is imprudent. Lending more short-term dollars does not hedge funding cost.

Did you get it right without looking?

One question tells you little. A timed set on Covered Interest Parity Lost: Understanding the Cross-Currency Basis shows your real accuracy, how long you take and where you lose marks.

Practise Covered Interest Parity Lost: Understanding the Cross-Currency BasisFree diagnostic mock

More Covered Interest Parity Lost: Understanding the Cross-Currency Basis questions