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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 331
The 'interest rate sensitivity report' sent to ALCO monthly shows:
Select an option first.
Correct answer: B — NII sensitivity (+/−100bp) by business line, EVE sensitivity under six standardised shocks, rate sensitivity by maturity bucket, and hedging effectiveness — enabling ALCO to manage IRRBB actively.
Explanation: Monthly IRRBB report to ALCO: NII sensitivity, EVE sensitivity, key rate sensitivities, hedge positions, YTD changes.
Question 332
A bank's 'structural FX position' arises when:
Select an option first.
Correct answer: B — The bank holds assets (e.g., foreign subsidiary investments) or liabilities denominated in foreign currencies as part of its normal business — creating an ongoing structural balance sheet FX exposure.
Explanation: Structural FX: strategic currency positions from banking operations — investments in foreign subsidiaries, foreign-currency lending, cross-border funding. Managed centrally by treasury.
Question 333
The 'capital adequacy' and 'liquidity adequacy' are both important but different because:
Select an option first.
Correct answer: B — Capital = ability to absorb losses (solvency); liquidity = ability to meet cash obligations (funding). A bank can be solvent but illiquid (can pay its debts but not immediately), or liquid but insolvent (has cash but assets < liabilities).
Explanation: Solvency vs liquidity: Northern Rock was initially solvent but illiquid. SVB became insolvent as HTM losses crystallised. Both dimensions must be managed.
Question 334
The 'funding gap' in a bank's 1-week time bucket shows −€500m. The most appropriate action is:
Select an option first.
Correct answer: B — Arrange rollover funding (interbank borrowing, repo, or CB facility) for the €500m gap BEFORE the liability matures. If HQLA can cover it, no external action is needed.
Explanation: 1-week funding gap: if HQLA is sufficient, draw on the liquidity buffer. If the gap is structural, arrange funding ahead of maturity. Proactive management is key.
Question 335
The 'delta of a deposit' in NMD modelling measures:
Select an option first.
Correct answer: B — The rate pass-through (sensitivity of deposit rates to market rates) — a delta of 0.3 means that when market rates rise 100bp, deposit rates only rise 30bp.
Explanation: Deposit delta (rate pass-through): how much of market rate changes are reflected in deposit rates. Low delta = deposit rate sticky = bank benefits less from rate hikes but funds more cheaply.
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Question 336
A bank's 'capital-at-risk from IRRBB' is estimated by:
Select an option first.
Correct answer: B — Calculating the maximum EVE decline under all standardised shocks and comparing to the bank's capital base — the capital needed to absorb the worst-case EVE decline.
Explanation: IRRBB capital estimate: worst-case ΔEVE under standardised shocks vs available capital. If ΔEVE > available capital cushion, Pillar 2 capital may be required.
Question 337
The concept of 'natural hedges' in ALM refers to:
Select an option first.
Correct answer: B — Offsetting risk exposures that already exist within the balance sheet — e.g., a retail bank with fixed-rate mortgages (assets) funded by fixed-rate bonds (liabilities) has a natural IRRBB hedge.
Explanation: Natural hedges: when asset and liability cash flows naturally offset each other without derivatives. E.g., fixed-rate loans + fixed-rate deposits = NIM protected from rate changes.
Question 338
The 'net interest income at risk' (NII-at-Risk) under a stress scenario of +200bp is calculated by:
Select an option first.
Correct answer: B — Simulating the NII over 1-3 years under a +200bp scenario (applied to the repricing cash flows as they mature and roll over) and comparing to the base case NII.
Explanation: NII-at-Risk: full income simulation incorporating: repricing of maturing positions at new rates, customer behaviour assumptions, and new business volume. Not a simple gap × rate.
Question 339
The 'basis point value' (BPV) or 'DV01' of the entire banking book interest rate risk position represents:
Select an option first.
Correct answer: B — The monetary change in EVE for a 1bp parallel upward shift in all interest rates — the primary measure used for IRRBB hedging and limit setting.
Explanation: BPV/DV01 of banking book: sums up all net cash flow sensitivities. Used to size interest rate swap hedges.
Question 340
The 'treasury single desk' model for FTP means:
Select an option first.
Correct answer: B — A centralised treasury function that manages all funding, IRRBB, and liquidity from a single desk — offering economies of scale, better risk visibility, and consistent pricing.
Explanation: Treasury single desk (or centralised model): one treasury manages all funding/IRRBB globally. Alternative = multiple regional treasuries (decentralised). Centralised = better risk aggregation, more efficient.
Question 341
A bank's 'loan-to-deposit ratio management' by ALCO ensures:
Select an option first.
Correct answer: B — Keeping the LDR within an approved range that balances growth objectives with funding stability — avoiding over-reliance on wholesale funding while meeting business targets.
Explanation: LDR management: too high = over-reliance on wholesale funding; too low = excess liquidity / inefficient use of deposit funding. ALCO sets target range.
Question 342
The 'hedging effectiveness' test for IRRBB hedges is important because:
Select an option first.
Correct answer: B — If a hedge loses effectiveness (e.g., basis changes, prepayments alter asset duration), the bank's IRRBB position changes unexpectedly — ongoing monitoring is needed to identify when hedges need rebalancing.
Explanation: Hedge effectiveness monitoring: IRRBB hedges (IRS) must be monitored for changes in basis, duration drift, and convexity that reduce hedge effectiveness over time.
Question 343
The 'economic capital' allocated to IRRBB risk within the bank's internal capital framework is based on:
Select an option first.
Correct answer: B — The maximum potential EVE decline under internal stress scenarios at a given confidence level — e.g., the 99.9th percentile EVE loss under the bank's internal rate scenarios.
Explanation: IRRBB economic capital: based on the distribution of EVE outcomes under the bank's internal rate scenarios. Supports ICAAP capital adequacy assessment.
Question 344
The 'gap report' aggregates repricing mismatches by maturity bucket. A bank with a large negative gap in the '1-3 month' bucket and a positive gap in '1-5 years' has:
Select an option first.
Correct answer: B — A 'twist risk' — NII is hurt if short-term rates rise independently of long-term rates (short-end rate hike without long-end movement). This is yield curve risk, not captured by a single duration measure.
Explanation: Twist/yield curve risk: mismatches at different maturities create opposing sensitivities. A +50bp at the short end with no long-end move creates NII loss (negative short-end gap) without the EVE gain from the positive long-end gap.
Question 345
The 'IRRBB limit framework' at a bank typically includes limits on:
Select an option first.
Correct answer: B — NII sensitivity (maximum NII decline under +/−X bp), EVE sensitivity (maximum EVE decline), BPV limits by currency and maturity, and tenor concentration limits.
Explanation: IRRBB limits: comprehensive framework covering NII sensitivity, EVE sensitivity (outlier test), BPV by currency/tenor, and tenor concentration. ALCO monitors against all limits.
Question 346
A bank's ALCO decides to 'reduce the duration of the investment portfolio' from 5 years to 3 years. The immediate effect on the bank's risk profile is:
Select an option first.
Correct answer: B — EVE sensitivity decreases (less rate risk) but carry income falls (shorter duration = lower yield in a normal upward-sloping curve) — trading lower income for lower IRRBB.
Explanation: Reducing investment portfolio duration: lowers EVE sensitivity (less rate-sensitive assets) but sacrifices carry income in normal upward-sloping yield curve environment.
Question 347
The 'constant balance sheet assumption' used in EVE calculations means:
Select an option first.
Correct answer: B — No new business is assumed beyond replacing maturing positions at the same volume — isolating the pure interest rate sensitivity of the existing balance sheet without growth/new business assumptions.
Explanation: Constant balance sheet: simplifying assumption in EVE allowing pure rate sensitivity calculation without confounding new business effects. Useful for standardised regulatory comparison.
Question 348
The 'dynamic balance sheet assumption' in NII simulation allows:
Select an option first.
Correct answer: B — Modelling of new business (new loans originated, new deposits raised) and management actions (repricing, hedging) over the simulation horizon — more realistic for medium-term NII projections.
Explanation: Dynamic balance sheet: NII simulation including new business and management response assumptions. More realistic than constant balance sheet for 1-3 year NII forecasts.
Question 349
The 'interest rate risk in the banking book' framework under EBA guidelines applies to:
Select an option first.
Correct answer: B — All institutions subject to CRD/CRR, with proportionality in how they apply it — but all banks must identify, measure, and manage IRRBB.
Explanation: IRRBB applies to all CRD/CRR institutions. EBA guidelines (EBA/GL/2018/02) implement BCBS 368 in Europe with proportionality.
Question 350
A bank's 'interest rate risk appetite' is typically expressed as:
Select an option first.
Correct answer: B — Maximum allowable NII decline as % of NII (e.g., ≤10%) under a +200bp shock AND maximum EVE decline as % of Tier 1 capital (e.g., ≤15%) — dual limits covering both perspectives.
Explanation: IRRBB risk appetite: dual expression — NII sensitivity limit (income protection) and EVE sensitivity limit (value protection). Both must be within approved bounds.
Question 351
The 'floors on interest rates' used in BCBS 368 standardised shocks for some currencies mean:
Select an option first.
Correct answer: B — For currencies where negative rates are observed (e.g., EUR, JPY historically), the downward rate shock is floored at a negative level to reflect the possibility of negative rates, not floored at zero.
Explanation: BCBS 368 floors: the parallel down shock is floored at the lower of the historical negative rate observed or a supervisory minimum (e.g., −1%) not at zero, reflecting negative rate realities in EUR/JPY.
Question 352
In FTP, the 'credit risk component' and 'liquidity/interest rate risk component' are separated because:
Select an option first.
Correct answer: B — Each component has a different cost driver and risk owner — credit risk FTP should reflect expected credit losses and is owned by the lending unit, while the interest rate/liquidity component is managed by treasury.
Explanation: FTP decomposition: credit risk premium (lending unit bears) + liquidity/IR premium (treasury manages). Correct separation ensures each business unit only takes the risks it can manage.
Question 353
A bank implementing a 'receive-fixed/pay-floating interest rate swap' to hedge a large fixed-rate mortgage portfolio will:
Select an option first.
Correct answer: B — Reduce the bank's EVE sensitivity by effectively converting fixed-rate asset cash flows to floating — the swap offsets the duration of the mortgage portfolio.
Explanation: Receive-fixed IRS on fixed mortgage book: effectively converts fixed-rate income to floating. Reduces asset duration → decreases positive duration gap → reduces EVE sensitivity to rising rates.
Question 354
The 'IRRBB governance' requirement under BCBS 368 Principle 1 states that the board must:
Select an option first.
Correct answer: B — Approve the IRRBB strategy, risk tolerance, and key policies — and be regularly informed of the bank's IRRBB exposures and hedging activities.
Explanation: BCBS 368 Principle 1: Board responsibility for IRRBB governance. Board approves strategy/tolerance, receives regular IRRBB reporting, and challenges management.
Question 355
A bank using 'interest rate options' (caps/floors/swaptions) for IRRBB management can hedge:
Select an option first.
Correct answer: B — Non-linear risks such as mortgage prepayment risk and deposit early withdrawal risk — options provide asymmetric protection that linear swaps cannot replicate.
Explanation: Options for IRRBB: swaptions/caps hedge the optionality in banking book products (mortgage prepayment = short call; deposit withdrawal = short put). These cannot be hedged with linear instruments alone.
Question 356
The 'market value of equity' approach to IRRBB measures:
Select an option first.
Correct answer: B — The economic value of the bank's equity = PV(assets) − PV(liabilities), which changes when interest rates shift the present values of assets and liabilities by different amounts.
Explanation: MVE = EVE: the economic/market value of shareholders' equity, which changes with interest rate moves. MVE/EVE management is the long-term IRRBB perspective.
Question 357
When ALCO instructs treasury to 'add duration to the investment portfolio', this means:
Select an option first.
Correct answer: B — Buying longer-maturity bonds or entering receive-fixed swaps — increasing the portfolio's sensitivity to rate changes and earning more carry in a normal upward-sloping yield curve.
Explanation: Adding duration: buy longer bonds or receive-fixed swaps. Increases EVE rate sensitivity but earns more carry (yield) in normal curve. ALCO makes this decision when expecting stable or falling rates.
Question 358
The 'hedge ratio' for an IRRBB swap hedge is determined by:
Select an option first.
Correct answer: B — DV01(swap) = DV01(hedged position) — matching dollar value of basis point changes so that a parallel rate shift creates zero net P&L.
Explanation: Hedge ratio: DV01-matching ensures net zero sensitivity to parallel rate shifts. A is a common mistake; C equates duration which doesn't account for different market values; D also misidentifies the metric.
Question 359
The 'reporting currency translation risk' in ALM arises when:
Select an option first.
Correct answer: B — Foreign-currency denominated assets and liabilities are converted to the reporting currency for financial statements — changes in exchange rates create reported P&L and capital volatility even without any economic loss.
Explanation: Translation risk: H1 results show large EUR/USD move → UK parent reports USD subsidiary results in GBP → reported profits affected even if USD performance was stable.
Question 360
The 'FTP for sight deposits' (demand deposits) reflects which effective maturity?
Select an option first.
Correct answer: B — A longer effective maturity based on behavioural analysis of deposit stability (e.g., 2-3 years for core deposits) — reflecting that most demand deposits are actually stable long-term funding.
Explanation: Demand deposit FTP: based on core deposit behavioural modelling. Core deposits are stable → assigned longer effective maturity → higher FTP credit for the branch. This is fair because the core deposit is economically equivalent to long-term funding.
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