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Free Questions › FRM › Liquidity and Treasury Risk Management
Free FRM Liquidity and Treasury Risk Management Practice Questions & Answers
400 exam-style Liquidity and Treasury Risk Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 301
CSRBB (Credit Spread Risk in the Banking Book) addresses:
Select an option first.
Correct answer: B — Risk that credit spreads on banking book bonds change independently of risk-free rates — creating EVE and NII sensitivities beyond pure rate risk.
Explanation: CSRBB (BCBS 368 revised): spread risk on non-HQLA banking book instruments distinct from risk-free rate IRRBB.
Question 302
A bank issues a €500m 3-year fixed bond at 4.5% and invests in floating-rate loan at EURIBOR+200bp. When rates rise:
Select an option first.
Correct answer: B — NII increases — the bank pays fixed (4.5%) on the bond but receives more floating as EURIBOR rises. This is a positive asset-sensitive IRRBB position.
Explanation: Pay-fixed bond + receive-floating loan: rising EURIBOR increases income; fixed cost unchanged → NII increases.
Question 303
A large BPV at USD 10-year in the IRRBB sensitivity matrix means:
Select an option first.
Correct answer: B — A 1bp movement in US 10-year rates will cause a significant EVE change — the bank has a large net position at this maturity point.
Explanation: BPV (basis point value) sensitivity matrix: large BPV at a maturity point = large net rate exposure there.
Question 304
The 'funding mix' optimisation in treasury balances:
Select an option first.
Correct answer: B — Cost (short-term is cheaper) vs stability (long-term is predictable) and concentration risk vs diversification.
Explanation: Funding mix: short-term cheaper but volatile; long-term expensive but stable. Optimise within liquidity risk appetite.
Question 305
The 'IRR' of a loan in FTP context represents:
Select an option first.
Correct answer: B — All-in loan return compared to FTP rate to determine whether the loan creates or destroys value.
Explanation: Loan value creation: lending rate − FTP − credit provisions − operating costs − capital charge > 0 = value created.
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Question 306
'Repricing risk' in IRRBB arises from:
Select an option first.
Correct answer: B — Timing differences between when assets and liabilities reprice — the gap creates NII exposure to rate changes.
Explanation: Repricing risk = most basic IRRBB: gap between asset and liability repricing dates.
Question 307
In a rising rate environment, fixed-rate bonds held as 'held-to-maturity' (HTM):
Select an option first.
Correct answer: B — Book value is unchanged — HTM is carried at amortised cost. Economic value falls but accounting value does not.
Explanation: HTM accounting: no mark-to-market. SVB held large HTM portfolios with large unrealised losses — invisible on P&L but real economically.
Question 308
'Yield curve risk' component of IRRBB occurs when:
Select an option first.
Correct answer: B — The shape of the yield curve changes (steepening, flattening, twist) — affecting relative value of assets and liabilities at different maturities.
Explanation: Yield curve risk = non-parallel shifts. Second major IRRBB component after repricing gap risk.
Question 309
ALCO extends the investment portfolio duration. This will:
Select an option first.
Correct answer: B — Increase EVE sensitivity to rate changes — longer-duration assets lose more value when rates rise, but earn more carry if rates remain stable.
Explanation: Extending duration: deliberate IRRBB risk-taking decision trading higher carry for higher rate sensitivity.
Question 310
Banking book vs trading book matters for IRRBB because:
Select an option first.
Correct answer: B — Banking book uses accrual accounting → Pillar 2 IRRBB; trading book uses mark-to-market → Pillar 1 market risk capital.
Explanation: Fundamental distinction: banking book = IRRBB (accrual/Pillar 2); trading book = market risk (MTM/Pillar 1).
Question 311
To reduce EVE sensitivity from €10bn of 30-year fixed mortgages funded by 3-month deposits, the three main ALCO tools are:
Select an option first.
Correct answer: B — (1) Receive-fixed IRS to extend effective liability duration; (2) Issue long-term fixed bonds; (3) Shift new origination from fixed to adjustable-rate mortgages.
Explanation: Duration gap reduction: IRS (receive-fixed/pay-floating), long-term bond issuance, shift to ARM mortgages reduce positive duration gap.
Question 312
Mortgage convexity is important for IRRBB management because:
Select an option first.
Correct answer: B — Prepayment options create negative convexity — when rates fall, prepayments accelerate (asset shortens, EVE benefit less than expected); when rates rise, prepayments slow (asset extends, EVE loss more than expected). Simple duration hedges become insufficient.
Explanation: Negative mortgage convexity requires options (swaptions, caps/floors) to hedge accurately. Linear duration hedges become inaccurate for large rate moves.
Question 313
In FTP design, the 'liquidity premium' component represents:
Select an option first.
Correct answer: B — The cost above the risk-free swap rate that reflects the bank's specific term funding spread — ensuring business units funding illiquid long-term assets pay the true all-in cost of stable funding.
Explanation: FTP liquidity premium = bank funding spread above swap = actual term funding cost. Business units must be charged this to make correct pricing decisions.
Question 314
A 'super-core deposit' in NMD behavioural modelling is:
Select an option first.
Correct answer: B — The most stable portion of NMDs with proven long-term historical stability — assigned the longest effective maturity (up to capped limits) in IRRBB calculations.
Explanation: NMD decomposition: super-core (longest stability, highest assigned maturity), core, volatile/transient.
Question 315
The EVE-NII tension in IRRBB management arises because:
Select an option first.
Correct answer: B — Actions improving EVE in a rising rate environment (paying-fixed swaps) reduce short-term NII; actions protecting NII (extending portfolio duration for carry) increase EVE risk — ALCO must balance both objectives.
Explanation: EVE-NII tradeoff: pay-fixed swap costs money (NII falls) but reduces duration gap (EVE improves).
Question 316
'Behavioural cash flows' differ from 'contractual cash flows' in ALM because:
Select an option first.
Correct answer: B — Behavioural flows incorporate customer actions (prepayments, early withdrawals, drawdowns) that alter actual cash flow timing from contractual schedules — essential for accurate NII/EVE modelling.
Explanation: Behavioural vs contractual: mortgages prepay; demand deposits stay; revolving lines partially drawn. ALM must use behavioural.
Question 317
A 'replication portfolio' strategy for NMD pricing means:
Select an option first.
Correct answer: B — Constructing a portfolio of fixed-income instruments whose cash flows mimic expected NMD behaviour — the portfolio's yield determines the FTP credit for NMDs.
Explanation: NMD replication portfolio: more sophisticated than a single maturity assumption; captures gradual portfolio turnover.
Question 318
An 'ILAAP' requires banks to:
Select an option first.
Correct answer: B — Comprehensively assess liquidity risks, liquidity risk appetite, buffer adequacy, stress testing results, and CFP quality — submitted for supervisory review.
Explanation: ILAAP: comprehensive internal self-assessment of all liquidity risks analogous to ICAAP for capital.
Question 319
In FTP, 'Earnings at Risk' (EaR) for a business unit captures:
Select an option first.
Correct answer: B — Potential NII reduction under an adverse rate scenario — NII shortfall under stress versus base case.
Explanation: EaR = NII sensitivity measure for each business unit. Helps ALCO allocate IRRBB risk budget.
Question 320
The 'pass-through rate' in NMD modelling measures:
Select an option first.
Correct answer: B — The proportion of market rate changes reflected in deposit rates — 50% pass-through means a 100bp market rate rise leads to only 50bp deposit rate increase.
Explanation: Rate pass-through: banks typically do not fully pass rate movements to depositors — partial pass-through is the norm.
Question 321
On a balance sheet with fixed assets (€50bn, 5yr duration) and floating assets (€30bn, 3mo), fixed liabilities (€60bn, 2yr duration), floating liabilities (€20bn, 3mo), equity €5bn — the duration gap is approximately positive, implying:
Select an option first.
Correct answer: B — Rising rates will reduce EVE — assets have longer average duration than liabilities.
Explanation: Asset-weighted duration > Liability-weighted duration (positive gap) → rising rates reduce EVE.
Question 322
After a 300bp rate rise with ΔEVE = −€1.8bn against equity €8bn, ALCO should:
Select an option first.
Correct answer: B — Recognise outlier status (22.5% > 15%), escalate to supervisor, prepare justification or reduce IRRBB — risk of Pillar 2 capital add-on.
Explanation: Outlier: 1.8/8 = 22.5% > 15%. Supervisor notified. ALCO must either justify or reduce EVE sensitivity.
Question 323
European variable-rate vs US fixed-rate mortgage portfolios create different IRRBB because:
Select an option first.
Correct answer: B — Variable-rate: NII changes with rates but limited EVE impact; Fixed-rate: primarily EVE risk (long duration) plus prepayment/pipeline risk. Different structural IRRBB profiles requiring different management strategies.
Explanation: European vs US: variable-rate → NII risk; fixed-rate → EVE risk. Fundamentally different IRRBB profiles.
Question 324
EURIBOR-ECB spread widening creates IRRBB because:
Select an option first.
Correct answer: B — Banks funding at ECB deposit rate but lending at EURIBOR face basis risk — if the spread narrows, NIM compresses even if rate levels are unchanged.
Explanation: Basis risk: EURIBOR includes bank credit risk premium; ECB rate is risk-free. Spread changes → residual NIM risk.
Question 325
A perfect DV01 hedge requires:
Select an option first.
Correct answer: B — DV01 of swap exactly equals DV01 of investment portfolio — matching dollar sensitivity per basis point.
Explanation: Perfect hedge: DV01_swap = DV01_portfolio. A 100bp move creates zero net EVE change.
Question 326
The 'IRRBB management framework' under BCBS 368 requires banks to have at minimum:
Select an option first.
Correct answer: B — Clearly defined risk appetite for IRRBB, internal measurement systems for IRRBB exposure, stress testing, internal reporting to ALCO and board, and hedging strategy aligned with risk appetite.
Explanation: BCBS 368 framework: risk appetite + measurement systems + stress testing + internal reporting + hedging strategy. Comprehensive governance required.
Question 327
The 'income gap' analysis in ALM measures:
Select an option first.
Correct answer: B — The difference between rate-sensitive assets and rate-sensitive liabilities in a specific time period — the same as the repricing gap, measuring NII sensitivity to rate changes.
Explanation: Income gap = repricing gap = RSA − RSL. The foundation of short-term NII sensitivity analysis.
Question 328
A 'negative duration gap' at a bank means:
Select an option first.
Correct answer: B — Liabilities have longer average duration than assets — when rates rise, liabilities lose more value than assets, increasing EVE (bank benefits from rate rises).
Explanation: Negative duration gap: D_A − (L/A)×D_L < 0. Rising rates: PV(liabilities) falls more than PV(assets) → EVE increases.
Question 329
The 'steepener' interest rate scenario (short rates fall, long rates rise) impacts a bank with positive duration gap by:
Select an option first.
Correct answer: B — Mixed impact: long rates rising increases NII on new long-term lending but also hurts EVE (long assets lose value); short rates falling reduces funding costs. Net effect depends on the specific balance sheet.
Explanation: Steepener impact on positive duration gap bank: short end down (lower funding costs, positive NII) but long end up (long assets lose EVE value, negative EVE). Complex interaction requiring scenario analysis.
Question 330
The 'ALCO investment policy' for the bank's investment portfolio typically includes:
Select an option first.
Correct answer: B — Permitted asset classes, credit quality limits, maximum duration, concentration limits, and objectives (HQLA maintenance, carry income, IRRBB management) — defining the investment mandate for treasury.
Explanation: Investment policy: multiple constraints — credit quality, duration, asset class, concentration, and strategic objectives. Governs the investment portfolio's management.
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