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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 91
The 'monetisation haircut' applied to HQLA reflects:
Select an option first.
Correct answer: B — The discount from market value incurred when quickly converting HQLA to cash — larger for less liquid HQLA (Level 2B vs Level 1).
Explanation: Level 1 HQLA: no haircut. Level 2A: 15% haircut. Level 2B: 25-50% haircut. Haircut compensates for illiquidity/price risk in a 30-day stress monetisation.
Question 92
A bank's 'cumulative net liquidity position' over a 30-day horizon is computed by:
Select an option first.
Correct answer: B — Summing all expected cash inflows minus all expected cash outflows across each time bucket up to 30 days.
Explanation: Cumulative net liquidity position: running sum of net flows (inflows − outflows) across all time buckets to the horizon. Negative at any point = funding gap requiring action.
Question 93
The term 'franchise run' describes:
Select an option first.
Correct answer: B — A situation where a bank's counterparties and depositors withdraw specifically because of concerns about the bank's franchise value (reputation/viability) rather than a general market crisis.
Explanation: Franchise run = idiosyncratic liquidity stress. Distinguished from a systemic run where all banks are affected simultaneously.
Question 94
When a central bank implements 'open market operations' (OMOs) by purchasing government bonds, the primary effect on bank liquidity is:
Select an option first.
Correct answer: B — Injecting reserves into the banking system — increasing bank liquidity and reducing the incentive for interbank lending.
Explanation: OMO bond purchases: CB creates reserves → banks receive cash → system-wide liquidity increases. Used to ease tight money market conditions.
Question 95
The 'pledging capacity' of a bank's balance sheet refers to:
Select an option first.
Correct answer: B — The amount of additional secured funding the bank could raise by pledging currently unencumbered assets as collateral.
Explanation: Pledging capacity = unencumbered eligible assets × (1 − haircut). It represents the remaining secured borrowing headroom. A key metric in CFP liquidity generation capacity.
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Question 96
'Intraday credit' (daylight overdraft) provided by a central bank helps banks by:
Select an option first.
Correct answer: B — Allowing banks to make large payments even before receiving offsetting inflows — preventing gridlock in RTGS systems by providing temporary intraday cash against collateral.
Explanation: Intraday credit: CB provides overnight-style collateralised credit within the day to allow RTGS systems to function smoothly. Without it, payment queuing and gridlock would be severe.
Question 97
The 'pass-through test' for HQLA under Basel III requires:
Select an option first.
Correct answer: B — The asset to be freely transferable and not subject to legal, contractual, or operational restrictions that would prevent the bank from monetising it in stress.
Explanation: Pass-through requirement: HQLA must have no impediment to conversion to cash. Legal restrictions, pledging constraints, or operational barriers mean an asset cannot qualify as HQLA.
Question 98
A bank's 'net stable funding' shortfall can be addressed by:
Select an option first.
Correct answer: B — Issuing longer-term debt (extending funding maturity), reducing illiquid long-term assets, or growing stable retail deposits.
Explanation: NSFR shortfall remediation: (1) increase ASF: issue long-term bonds, grow stable deposits; (2) reduce RSF: sell/securitise long-term illiquid assets, shorten asset maturity profile.
Question 99
The 'term structure of funding' in a bank refers to:
Select an option first.
Correct answer: B — The distribution of liability maturities across time buckets — indicating how much funding matures in each period and must be rolled over or replaced.
Explanation: Term structure of funding: the maturity ladder of liabilities. A steep front-end concentration = high near-term rollover risk. Diversifying across maturities reduces this risk.
Question 100
'Rehypothecation' creates liquidity risk because:
Select an option first.
Correct answer: B — Securities posted as collateral may be re-used by the receiving party, creating chains of obligations that can unwind rapidly in stress — the original collateral poster may not get securities back when needed.
Explanation: Rehypothecation: client securities re-pledged by prime broker. In stress: PB defaults → client cannot recover securities → client liquidity crisis. 2008 crisis highlighted this risk.
Question 101
A bank experiencing a 'run on its repo book' means:
Select an option first.
Correct answer: B — Counterparties refuse to roll over secured (repo) borrowing or demand much larger haircuts — forcing the bank to find alternative funding or sell assets rapidly.
Explanation: Repo run: secured funding markets freeze for the specific bank. Counterparties demand higher haircuts or refuse to roll over. Bear Stearns and Lehman both experienced repo book runs.
Question 102
The difference between the 'liquidity coverage ratio' and the 'net stable funding ratio' is best described as:
Select an option first.
Correct answer: B — LCR addresses short-term (30-day) stress resilience; NSFR addresses structural (1-year) funding sustainability. Together they cover both short-term and longer-term liquidity risks.
Explanation: LCR vs NSFR: complementary — short-term buffer (LCR) and structural balance sheet soundness (NSFR).
Question 103
The 'additional monitoring metrics' (AMM) under EU CRR/ALMM require banks to report:
Select an option first.
Correct answer: B — Detailed liquidity data including contractual maturity ladder, concentration of funding, cost of funding, rollover of funding, and currency mismatch — providing supervisors granular insight.
Explanation: EU ALMM: granular supervisory returns supplementing LCR/NSFR with contractual maturity ladder, concentration metrics, pricing, and rollover data.
Question 104
The 'liquidity stress test horizon' beyond 30 days (e.g., 90 days, 1 year) is important because:
Select an option first.
Correct answer: B — Some liquidity crises extend well beyond 30 days — medium-term stress scenarios are needed to ensure the bank can survive a prolonged market disruption.
Explanation: Extended horizon stress: e.g., the 2008 crisis lasted years, not weeks. Internal stress tests should cover 30-day, 90-day, and 1-year horizons to ensure structural resilience.
Question 105
The 'systemic liquidity risk contribution' of a large bank is primarily driven by:
Select an option first.
Correct answer: B — Its size, interconnectedness (direct exposures to other institutions), substitutability (whether its services can easily be replaced), and the spillover effects of its potential failure.
Explanation: Systemic liquidity contribution: size, interconnectedness, substitutability. G-SIBs with high interconnectedness amplify systemic liquidity stress when they fail.
Question 106
A bank operates a 'liquidity pool' structure where liquidity is managed centrally for a banking group. The primary benefit is:
Select an option first.
Correct answer: B — Centralised HQLA pool can be allocated to wherever the stress occurs within the group — reducing the total buffer needed versus each entity holding a standalone buffer.
Explanation: Centralised liquidity pool: diversification benefit — not all entities stressed simultaneously. Reduces overall group HQLA requirement vs sum of standalone requirements. Subject to legal/regulatory constraints (ring-fencing).
Question 107
The 'liquid asset buffer' (LAB) in the UK PRA framework is conceptually equivalent to:
Select an option first.
Correct answer: B — The pool of high-quality liquid assets a bank maintains to meet liquidity obligations in the event of stress — broadly equivalent to the LCR HQLA requirement.
Explanation: UK LAB ≈ HQLA in LCR. The PRA requires banks to maintain unencumbered liquid assets sufficient to cover stress outflows over the ILG (Individual Liquidity Guidance) period.
Question 108
In a 'double liability' stress, the bank's 'liability side' problem is:
Select an option first.
Correct answer: B — Depositors and wholesale creditors simultaneously withdrawing — reducing the bank's available cash and short-term funding.
Explanation: Double liability: (1) funding squeeze = liability side (depositors/creditors withdrawing); (2) asset value decline = asset side. Both hitting simultaneously creates compounded stress.
Question 109
The primary risk of relying on 'committed central bank facilities' as a liquidity reserve is:
Select an option first.
Correct answer: B — The bank may not be prepared to operationally draw on these facilities quickly, or the eligible collateral pool may be smaller than expected — the facility must be tested and operationally ready.
Explanation: CB facility operational readiness: the key risk is not that the CB refuses, but that the bank cannot execute quickly (no ISDA/repo agreements, insufficient eligible collateral pre-positioned, untested operational processes).
Question 110
'Funding diversification' in liquidity risk management means:
Select an option first.
Correct answer: B — Spreading funding across multiple instruments (bonds, deposits, repo, covered bonds), maturities, currencies, and counterparties to reduce dependence on any single source.
Explanation: Funding diversification: multiple instruments, currencies, maturities, and counterparties. Reduces cliff risk from any single source failing.
Question 111
The 'additional outflow for downgrade triggers' in LCR accounts for:
Select an option first.
Correct answer: B — The collateral that must be posted or the funding that runs off if the bank's credit rating is downgraded by a specified number of notches — a contractual liquidity cliff.
Explanation: Downgrade triggers: derivative CSAs, loan agreements, and securities contracts often specify collateral posting requirements triggered by rating changes. These are included as LCR outflows.
Question 112
The 'maturity bucket' most critical for intraday liquidity purposes is:
Select an option first.
Correct answer: B — The intraday or 'same-day' bucket — payments must settle within hours, creating the most immediate liquidity demand.
Explanation: Intraday is the most time-critical maturity. Failures to pay within minutes in RTGS trigger settlement failure cascades.
Question 113
The 'core deposit' concept in US banking (and equivalent in other jurisdictions) refers to:
Select an option first.
Correct answer: B — The stable, long-standing portion of bank deposits that tends to remain even when interest rates change — the bedrock of a bank's funding base.
Explanation: Core deposits: empirically stable, rate-insensitive deposit base. Represents the bank's most reliable funding source for ALM and long-term balance sheet planning.
Question 114
A bank uses 'secured overnight financing rate' (SOFR) plus a spread as its benchmark for FTP. When SOFR rises by 50bp, the FTP rate for new floating-rate loans:
Select an option first.
Correct answer: B — Increases by approximately 50bp — the cost of short-term funding has risen, increasing the FTP charged to the lending business.
Explanation: FTP follows market funding costs. SOFR+50bp in FTP = correct internal signal of higher short-term funding costs. Lending business must price loans accordingly.
Question 115
Why is the '30-day LCR horizon' specifically chosen rather than, say, a 7-day or 90-day horizon?
Select an option first.
Correct answer: B — 30 days is the period during which central banks and supervisors would realistically intervene to stabilise a distressed bank — the buffer is designed to 'buy time' for official support or private rescue.
Explanation: 30-day rationale: the LCR buys time for supervisory/central bank intervention. Historical analysis showed that liquidity crises (Bear Stearns, Lehman) escalated rapidly; 30 days was judged the minimum intervention window.
Question 116
The 'collateral transformation' trade (upgrading collateral from lower-quality to HQLA-eligible) creates systemic risk because:
Select an option first.
Correct answer: B — It creates interconnections between institutions and can amplify stress if the upgraded collateral loses value or the transformation trades unwind simultaneously.
Explanation: Collateral transformation: firms borrow HQLA (e.g., Treasuries) against lower-quality securities. Creates: (1) additional interconnections; (2) fire sale risk if lower-quality collateral must be sold; (3) potential illusion of HQLA that is actually already encumbered elsewhere.
Question 117
A bank's treasury calculates the 'liquidity value at risk' (LVaR) of its bond portfolio at €50m. This means:
Select an option first.
Correct answer: B — There is a specified probability (e.g., 1%) that the cost of liquidating the portfolio in stress will exceed €50m — combining price impact and bid-ask spread costs.
Explanation: LVaR: probabilistic measure of the additional cost (beyond the standard MTM loss) of actually liquidating a position under stress. Analogous to financial VaR but measuring liquidity cost.
Question 118
The 'velocity of liquidity stress' in modern banks is higher than in historical crises because:
Select an option first.
Correct answer: B — Digital banking, social media, and real-time payment systems allow depositors to withdraw funds instantaneously and coordinate withdrawals globally within hours — far faster than physical bank run queues.
Explanation: Digital bank run velocity: SVB lost $42bn in 1 day. WhatsApp/Twitter/Reddit enable rapid coordination. LCR's 30-day window may be insufficient for some digital-era scenarios.
Question 119
The 'liquidity coverage ratio by currency' (LCR by currency) metric is particularly important for:
Select an option first.
Correct answer: B — Banks with significant cross-currency business where foreign currency outflows cannot easily be met by home currency HQLA — identifying foreign currency liquidity mismatches.
Explanation: LCR by currency: identifies if foreign currency HQLA is available to meet foreign currency outflows. A bank with large USD outflows but only EUR HQLA has a hidden currency mismatch risk.
Question 120
The 'net overnight funding requirement' (NOFR) measures:
Select an option first.
Correct answer: B — The amount of new overnight funding the bank must raise each day to meet its obligations — higher NOFR indicates greater daily rollover risk.
Explanation: NOFR = total overnight/short-term funding maturing that must be rolled over. High NOFR = high daily rollover dependency. A critical vulnerability in wholesale-funded banks.
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