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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 361
Under the BCBS IRRBB framework, banks must disclose:
Select an option first.
Correct answer: B — EVE sensitivity under the six standardised shocks and NII sensitivity under parallel shifts — enabling market participants to compare IRRBB across banks.
Explanation: BCBS 368 disclosure: standardised EVE and NII sensitivities published. Enables horizontal comparison across banks.
Question 362
The 'mortgage pipeline risk' in IRRBB refers to:
Select an option first.
Correct answer: B — The rate risk arising from mortgage applications that have been approved and locked at a specific rate but not yet funded — if rates change before funding, the bank bears the risk of delivering at a below-market rate.
Explanation: Pipeline risk: bank has committed to a mortgage rate (rate lock) but hasn't yet funded the mortgage. Interest rate moves between lock and funding create IRRBB.
Question 363
The 'sensitivity of NII to a flattening yield curve' is positive for a bank that has:
Select an option first.
Correct answer: B — More short-term assets than short-term liabilities in the near-term buckets AND more long-term liabilities than long-term assets — benefiting when short rates rise and long rates fall (flattening).
Explanation: Flattening beneficiary: positive short-end gap (benefits from short rate rise) + negative long-end gap (benefits from long rate fall). This bank profits from the classic monetary tightening cycle (CB hikes short rates, long rates lag).
Question 364
In a 'transfer pricing study' for ALM, the 'opportunity cost' method sets the FTP at:
Select an option first.
Correct answer: B — The marginal cost of raising equivalent-duration funding in the market today — ensuring the FTP reflects the current economic cost rather than historical sunk costs.
Explanation: Marginal cost FTP: current market cost of raising equivalent-tenor funding. Ensures new business pricing reflects the actual opportunity cost of deploying the bank's balance sheet today.
Question 365
A bank's ALCO reviews a proposal to increase corporate lending by €5bn. The ALCO's primary liquidity consideration is:
Select an option first.
Correct answer: B — Whether the additional €5bn of loans can be funded within the bank's NSFR/LCR framework, the existing funding plan, and without breaching liquidity risk appetite limits.
Explanation: ALCO liquidity review of new business: can we fund this within approved liquidity risk appetite? Does it worsen NSFR? Does it require new bond issuance or reduces the HQLA buffer?
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Question 366
The 'embedded optionality assessment' required under BCBS 368 means banks must:
Select an option first.
Correct answer: B — Identify and quantify both 'automatic' (contractual) and 'behavioural' (customer-driven) options in banking book products and model their impact on IRRBB under different rate scenarios.
Explanation: Embedded options: automatic (contractual rate caps/floors) and behavioural (customer prepayment decisions driven by rate incentives) must both be modelled. BCBS 368 requires explicit treatment.
Question 367
A bank with a large 'positive repricing gap at the 3-month horizon' benefits from:
Select an option first.
Correct answer: B — Rising short-term interest rates — more assets reprice upward quickly, increasing NII in the near term.
Explanation: Positive 3-month gap: RSA > RSL in 3-month bucket. Short-term rate hike → assets reprice faster than liabilities → NII increases.
Question 368
In FTP design, the 'margin compression risk' arises when:
Select an option first.
Correct answer: B — The FTP rate rises faster than the bank can reprice its existing fixed-rate loan book — squeezing the margin earned by the lending business on older loans.
Explanation: Margin compression in FTP: if FTP rises (higher funding costs) but fixed-rate loans cannot be repriced, the lending unit's margin (lending rate − FTP) compresses. This is the mechanism by which rising rates hurt bank profitability.
Question 369
The 'macro-hedging' approach to IRRBB management differs from 'micro-hedging' in that:
Select an option first.
Correct answer: B — Macro-hedging manages the net open IRRBB position of the entire balance sheet with a portfolio of hedges; micro-hedging assigns a specific hedge to each individual transaction.
Explanation: Macro vs micro hedging: macro = efficient (hedge the net book position); micro = precise but expensive (each position hedged individually). Most banks use a combination.
Question 370
The 'post-trade confirmation' of an interest rate swap used as an IRRBB hedge must include:
Select an option first.
Correct answer: B — All material economic terms: fixed rate, floating rate index, payment dates, notional, maturity, day count, compounding, settlement, and break clauses — ensuring the hedge functions exactly as modelled.
Explanation: Swap confirmation documentation: all economic terms must match the hedge's modelled effect. Errors in day count, payment frequency, or notional create unexpected IRRBB exposures.
Question 371
An ALCO is told that the bank's NII sensitivity to a +200bp shock is +€100m and EVE sensitivity is −€800m. This combination suggests the bank:
Select an option first.
Correct answer: B — Has a positive repricing gap (benefits from rate rises in the short term — NII up) but a large positive duration gap (EVE falls as long-duration assets lose value) — classic example of short-term income gain but long-term value loss.
Explanation: Short-term NII gain + long-term EVE loss: the bank earns more NII immediately as rates rise (positive repricing gap) but the long-term value of the balance sheet falls (positive duration gap). Classic banking book risk tension.
Question 372
The 'residual risk' in IRRBB after all hedges are in place represents:
Select an option first.
Correct answer: B — The net open interest rate risk position that cannot be fully hedged due to basis risk, model risk, and the impracticality of perfectly hedging every cash flow — this residual must remain within the risk appetite.
Explanation: Residual IRRBB: after hedging, some basis risk, model uncertainty, and practical constraints leave a residual open position. ALCO monitors this against the residual risk limit.
Question 373
A bank's 'net interest income simulation' shows that NII will decline by €200m under a +300bp scenario compared to the base case. If this exceeds the board-approved NII-at-risk limit of €150m, the ALCO should:
Select an option first.
Correct answer: B — Review and reduce the IRRBB position — through hedging (pay-fixed swaps), reducing fixed-rate asset origination, or shortening the investment portfolio duration — to bring NII sensitivity within approved limits.
Explanation: NII limit breach: the ALCO must act to reduce the IRRBB position. Options: (1) pay-fixed swaps reducing fixed rate asset duration; (2) originate fewer fixed-rate loans; (3) shorten investment portfolio.
Question 374
The 'rollover risk' in a bank's funding plan arises when:
Select an option first.
Correct answer: B — A large volume of term funding matures in a short period, requiring the bank to simultaneously refinance significant amounts — creating concentration in time of renewal.
Explanation: Rollover risk: maturity concentration in funding liabilities. E.g., €5bn of bonds maturing in Q1 is harder to refinance than €500m each quarter. ALCO manages this by spacing maturities across the funding calendar.
Question 375
A 'pro-forma balance sheet' in ALCO planning is used to:
Select an option first.
Correct answer: B — Project the bank's balance sheet over the planning horizon under base and stress assumptions — enabling ALCO to see the forward liquidity and IRRBB implications of planned business growth.
Explanation: Pro-forma balance sheet: forward-looking balance sheet incorporating planned business growth, funding actions, and interest rate assumptions. Key tool for ALCO strategic planning.
Question 376
The 'funding maturity profile' report presented to ALCO monthly shows:
Select an option first.
Correct answer: B — The scheduled maturities of all funding liabilities by time bucket — enabling ALCO to identify upcoming refinancing needs and potential maturity concentrations requiring advance planning.
Explanation: Funding maturity profile: liability maturity ladder. ALCO uses this to plan bond issuances, manage rollover risk, and ensure the funding plan covers all scheduled maturities.
Question 377
The 'interest rate risk transfer' from business lines to treasury via FTP means:
Select an option first.
Correct answer: B — When a business line books a fixed-rate loan at the FTP rate, the IRRBB from that loan is transferred to treasury — business units earn only the spread (lending rate minus FTP), and treasury manages the residual interest rate risk.
Explanation: FTP IRRBB transfer: the FTP 'locks in' the business unit's margin regardless of rate moves. All IRRBB is centralised in treasury, which then hedges or manages it. This is the core purpose of matched-maturity FTP.
Question 378
An 'ALCO heat map' typically shows:
Select an option first.
Correct answer: B — A visual representation of the bank's key risk positions (NII sensitivity, EVE sensitivity, LCR, NSFR, funding concentrations) colour-coded by proximity to risk limits — enabling quick identification of areas requiring attention.
Explanation: ALCO heat map: management information tool. Green = well within limits. Amber = approaching limits. Red = at/beyond limits. Covers IRRBB, liquidity, funding metrics simultaneously.
Question 379
The 'effective maturity' assigned to a fixed-rate mortgage in FTP is typically:
Select an option first.
Correct answer: B — A shorter behavioural maturity based on expected prepayment rates — if 25% of mortgages prepay in year 3, the effective maturity is shorter than the 25-year stated term, affecting FTP pricing.
Explanation: Effective maturity in FTP for mortgages: prepayment-adjusted duration, not stated contractual maturity. E.g., a 25-year mortgage with 20% CPR might have an effective duration of 7 years.
Question 380
A bank's 'asset-liability mismatch' is considered 'structural' when:
Select an option first.
Correct answer: B — It arises from the inherent nature of the bank's business model — e.g., a retail bank naturally takes short-term deposits (liabilities) and makes long-term mortgages (assets) creating a permanent structural gap.
Explanation: Structural ALM mismatch: inherent to the business model. Retail bank = naturally short-funded (deposits) vs long-invested (mortgages). This is the permanent background risk that ALM manages.
Question 381
The 'treasury funding plan execution' involves:
Select an option first.
Correct answer: B — Accessing capital markets to issue bonds, arranging repo facilities, growing deposits, and managing the maturity profile of the bank's funding liabilities in line with the ALCO-approved plan.
Explanation: Funding plan execution: treasury operationalises the ALCO-approved plan — bond roadshows, investor meetings, deposit pricing, repo management. The plan is executed in capital markets.
Question 382
The 'earnings at risk' (EaR) concept for ALM purposes measures:
Select an option first.
Correct answer: B — The potential decline in NII under an adverse scenario relative to the expected base-case NII — quantifying the downside risk to bank earnings from interest rate changes.
Explanation: EaR = base-case NII minus stressed NII under adverse rate scenario. E.g., if base NII = €1bn and stressed NII = €800m, EaR = €200m.
Question 383
A bank 'overlays' its IRRBB model with a 'management judgement' adjustment when:
Select an option first.
Correct answer: B — The model does not fully capture a specific risk — such as a new product feature, a structural market change, or a known model limitation — and management must adjust the model output to better reflect reality.
Explanation: Model overlays: when the IRRBB model cannot fully capture a risk (e.g., new deposit product, SVB-style uninsured deposit concentration), management adds a conservative overlay. Must be documented and governed.
Question 384
The 'ALM book' managed by treasury contains:
Select an option first.
Correct answer: B — The portfolio of derivatives (interest rate swaps, swaptions, FX forwards) and investment securities held specifically to manage the bank's IRRBB and structural balance sheet risks.
Explanation: ALM book: treasury's portfolio of hedging instruments and investments. Distinct from the trading book (intent = profit) and banking book customer transactions. ALM book instruments serve a balance sheet management purpose.
Question 385
When a bank's ALCO discusses 'balance sheet optimisation,' this refers to:
Select an option first.
Correct answer: B — Adjusting the composition and structure of the balance sheet to achieve the optimal combination of risk-adjusted profitability, capital efficiency, liquidity, and IRRBB — within the bank's risk appetite constraints.
Explanation: Balance sheet optimisation: holistic ALCO exercise covering capital efficiency (RWA optimisation), liquidity (LCR/NSFR), funding cost, NIM, IRRBB, and strategic positioning.
Question 386
The 'net liquidity position' of the bank at a given maturity horizon is best understood as:
Select an option first.
Correct answer: B — Cumulative cash inflows minus cumulative cash outflows from the present to that horizon, including the liquidity buffer — showing whether the bank is in surplus or deficit at each future point.
Explanation: Net liquidity position = cumulative net flows + HQLA buffer. Positive = surplus (more inflows than outflows covered by HQLA). Negative = deficit (bank must source additional funding).
Question 387
The 'IRRBB model validation' process assesses:
Select an option first.
Correct answer: B — Whether the model is conceptually sound, properly calibrated to historical data, producing accurate sensitivity estimates, and whether the assumptions (especially behavioural) remain appropriate.
Explanation: IRRBB model validation: model risk management for ALM models — conceptual soundness, calibration, backtesting of behavioural assumptions, independent review. Increasingly required by supervisors.
Question 388
The 'deposit beta' in an NMD model is the rate pass-through coefficient. A deposit beta of 0.4 means:
Select an option first.
Correct answer: B — When market rates rise by 100bp, the deposit rate paid to customers rises by 40bp — the bank retains 60bp of the rate rise as additional NIM.
Explanation: Deposit beta: rate pass-through coefficient. Beta=0.4 → deposit rate rises 40% of market rate rise. Bank captures remaining 60% as NIM improvement. Key driver of NII sensitivity in rising rate environments.
Question 389
The 'sensitivity of EVE to a parallel rate shock' can be approximated as:
Select an option first.
Correct answer: B — −Duration gap × ΔRate × Total assets — showing that a positive duration gap combined with a rate rise reduces EVE, with the magnitude proportional to both the gap and total assets.
Explanation: EVE approximation: ΔEVE ≈ −Duration gap × ΔRate × Assets. Positive gap + rising rates → negative ΔEVE. This relationship underpins the Basel outlier test design.
Question 390
A bank's 'interest rate swap notional' used for IRRBB hedging is typically much larger than its economic capital because:
Select an option first.
Correct answer: B — Swap notional is used only to calculate cash flows — a €1bn notional swap might hedge only a few million euros of annual rate sensitivity (DV01 × 10,000 bp). The notional itself is not at risk.
Explanation: IRS notional vs economic risk: the notional is a scaling factor. The actual economic risk = notional × duration × rate change. A €1bn 5-year swap has DV01 ≈ €50,000 per bp — the economic risk is a tiny fraction of the notional.
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