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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 121
A bank's 'liquidity value creation' (from maintaining a liquidity buffer) arises from:
Select an option first.
Correct answer: B — Reducing the probability and cost of liquidity crises — the option value of having liquid assets available in stress outweighs the negative carry cost of holding low-yielding HQLA.
Explanation: Liquidity buffer economic value: the option value (avoiding crisis costs) + insurance value (maintaining franchise) outweighs the carry cost. A positive NPV investment in normal times.
Question 122
The 'specific liquidity requirements' (SLR) imposed by supervisors on specific banks reflect:
Select an option first.
Correct answer: B — Individual risk-based assessment — a bank with higher funding concentration, weaker governance, or lower HQLA quality may receive a higher SLR than peers with identical LCR ratios.
Explanation: SLR = institution-specific supervisory liquidity requirement set after ILAAP/SREP review, reflecting each bank's unique risk profile.
Question 123
The 'negative carry' of holding a large HQLA portfolio is measured by:
Select an option first.
Correct answer: B — The yield forgone by investing in low-yielding HQLA (e.g., government bonds at 3%) instead of higher-yielding assets (e.g., corporate loans at 6%) — representing the economic cost of the liquidity buffer.
Explanation: Negative carry = opportunity cost: (loan yield − HQLA yield) × HQLA portfolio size. At scale, this can be hundreds of millions per year.
Question 124
Under Basel III, 'excess reserves' at the central bank qualify as:
Select an option first.
Correct answer: B — Level 1 HQLA with no haircut — reserves deposited at the central bank are the most liquid possible asset.
Explanation: Central bank reserves = Level 1 HQLA. No haircut, highest quality, most liquid. The central bank will always honour withdrawal of reserves.
Question 125
A bank's 'liquidity risk tolerance statement' approved by the board is most useful because:
Select an option first.
Correct answer: B — It provides clear, measurable boundaries for the treasury and risk management functions — defining the maximum acceptable risk and triggering escalation when limits are approached.
Explanation: Liquidity risk tolerance statement: operational utility = clear limits for treasury and risk management with defined escalation. Not just regulatory formalism.
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Question 126
'Payment netting' between banks in clearing systems reduces intraday liquidity needs by:
Select an option first.
Correct answer: B — Offsetting reciprocal payment obligations so that only the net amount between banks needs to be settled — dramatically reducing the gross liquidity required for settlement.
Explanation: Multilateral netting (deferred net settlement systems): banks settle net positions instead of gross — e.g., Bank A owes Bank B €500m and B owes A €480m → net settlement of €20m instead of €980m gross.
Question 127
The 'eligible collateral pool' for a bank's central bank repo facility must be:
Select an option first.
Correct answer: B — Pre-identified, pre-positioned, legally perfected collateral that meets the central bank's eligibility criteria — and can be pledged quickly without operational delay.
Explanation: CB eligible collateral: pre-positioned for operational readiness (key for CF planning), legally perfected (title transfer complete), eligible under CB criteria. Each CB has different eligibility lists.
Question 128
Why is 'concentration in HQLA' by instrument type a concern even if total HQLA meets LCR requirements?
Select an option first.
Correct answer: B — If the bank's HQLA is concentrated in one asset class (e.g., only one sovereign's bonds), a sudden price disruption in that asset class could reduce the HQLA value below requirements even without outflows.
Explanation: HQLA concentration risk: e.g., Greek sovereign bonds as HQLA in 2010-11 — their value collapsed precisely when funding stress was highest. Diversification across issuers and asset classes reduces this risk.
Question 129
The 'liquidity risk premium' in the FTP for a 10-year covered bond issued by the bank differs from a 3-month commercial paper FTP by:
Select an option first.
Correct answer: B — The 10-year covered bond FTP includes a significantly higher liquidity premium for the longer commitment to stable funding — compensating for the term liquidity risk and the structural benefit of stable long-term funding.
Explanation: Term liquidity premium: longer-dated funding = higher term premium in FTP. This incentivises business units to prefer shorter funding (cheaper for them) — treasury must charge appropriately to reflect true term cost.
Question 130
The 'Basel principles for liquidity risk management' (BCBS 2008) Principle 9 states that banks should:
Select an option first.
Correct answer: B — Actively monitor and control liquidity risk across legal entities, business lines, and currencies, recognising legal, regulatory, and operational limitations on the transfer of liquidity within the group.
Explanation: BCBS 2008 Principle 9: intragroup liquidity management must account for legal and operational barriers to intragroup liquidity transfer — group-level surplus may not be accessible to a stressed subsidiary.
Question 131
A bank's 'liquidity risk indicator dashboard' should minimally include which metrics?
Select an option first.
Correct answer: B — LCR, NSFR, survival horizon, HQLA level and composition, net funding gap, early warning indicators (CDS spread, equity price, CB facility usage), and concentration metrics.
Explanation: Comprehensive liquidity dashboard: LCR, NSFR, survival horizon, HQLA, funding gap, EWIs, concentrations. Enables ALCO to monitor all dimensions of liquidity risk.
Question 132
When a bank's LCR falls below 100%, Basel III requires the bank to:
Select an option first.
Correct answer: B — Notify the supervisor and submit a plan to restore the LCR to the minimum, including the timing and the actions to be taken — immediate action is required but the plan can phase restoration over time.
Explanation: LCR breach response: Basel requires notification to supervisors and a restoration plan. The bank does not automatically close — time is given for remediation depending on severity and supervisory judgment.
Question 133
The 'contingent funding capacity' of a bank includes all of the following EXCEPT:
Select an option first.
Correct answer: B — Future loan originations expected in the next quarter.
Explanation: Contingent funding capacity = monetisable resources that ALREADY EXIST on the balance sheet: unencumbered assets, CB facilities, committed lines. Future new business (B) does not exist yet and cannot be counted as available liquidity in stress.
Question 134
When a supervisor states that a bank's HQLA buffer is 'operationally inadequate,' this most likely means:
Select an option first.
Correct answer: B — The bank holds HQLA that cannot be monetised quickly due to operational barriers — such as assets held in subsidiaries with transfer restrictions, assets pledged in long-term repos, or systems that cannot execute rapid sales.
Explanation: Operationally inadequate HQLA: the test is not just holding the asset but being able to convert it to cash quickly. Operational barriers (legal, contractual, system) make HQLA effectively illiquid even if it meets the definitional criteria.
Question 135
The 'Basel III LCR monitoring period' requires that after an LCR breach, a bank must notify the supervisor and submit a restoration plan within:
Select an option first.
Correct answer: B — As soon as practicable — the supervisor must be notified promptly and a restoration plan submitted based on supervisory guidance, with the timeline reflecting the severity of the breach and market conditions.
Explanation: LCR breach notification and restoration: immediate supervisor notification required. Restoration timeline is supervisory judgment — severe breaches require faster action. The bank must not wait for reporting cycles.
Question 136
Basel III introduced two minimum liquidity standards:
Select an option first.
Correct answer: B — Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).
Explanation: LCR (30-day stress resilience) and NSFR (1-year structural liquidity) are the two Basel III liquidity minimums.
Question 137
Basel III Supervisory Monitoring Metrics (BCBS 248) include:
Select an option first.
Correct answer: B — Contractual maturity mismatch, funding concentration, available unencumbered assets, LCR by currency, and market-related monitoring tools.
Explanation: BCBS 248 monitoring tools supplement LCR/NSFR with five additional supervisory datasets.
Question 138
Under EU LCR regulation, simplified requirements may apply to:
Select an option first.
Correct answer: B — Small non-complex institutions meeting simplicity criteria — proportionality reduces compliance burden.
Explanation: Proportionality: smaller, simpler institutions may use simplified LCR requirements under CRR2.
Question 139
A bank's recovery plan must include liquidity recovery actions such as:
Select an option first.
Correct answer: B — Asset sales, CB facility access, covered bond issuance, dividend cuts — each quantified for speed and volume, providing a menu of liquidity generation options.
Explanation: BRRD recovery plans: a menu of pre-designed liquidity actions with quantified impact and execution timelines.
Question 140
The resolution plan ('living will') includes liquidity considerations because:
Select an option first.
Correct answer: B — A bank in resolution needs cash to maintain critical functions during wind-down — the plan must ensure adequate pre-positioned liquidity in each resolution entity.
Explanation: Resolution liquidity: TLAC pre-positioning, critical function funding, and intragroup liquidity flows must all be planned.
Question 141
The EBA EU-wide bank stress test differs from internal liquidity stress tests because:
Select an option first.
Correct answer: B — The EBA uses a standardised public scenario applied consistently across all banks — enabling cross-bank comparison. Internal tests are institution-specific.
Explanation: EBA stress test: standardised, public, comparative. Internal: institution-specific, proprietary, all-risk.
Question 142
TLAC requirements affect liquidity risk at G-SIBs because:
Select an option first.
Correct answer: B — Issuing bail-in bonds (TLAC instruments) changes the funding structure and maturity profile, affecting structural liquidity. TLAC must be pre-positioned in resolution entities.
Explanation: TLAC-liquidity: long-term bail-in bond issuance improves NSFR but creates structural complexity in group liquidity.
Question 143
The PRA/ECB supervisory review of ILAAP assesses:
Select an option first.
Correct answer: B — Adequacy of the self-assessment of liquidity risks, robustness of stress testing, buffer appropriateness, and quality of governance and management processes.
Explanation: ILAAP review: risk identification completeness, stress severity, buffer adequacy, CFP quality, governance.
Question 144
The 'proportionality principle' in liquidity regulation means:
Select an option first.
Correct answer: B — Requirements are calibrated to institution size, complexity, and systemic importance — smaller banks may comply with simplified versions.
Explanation: Proportionality: G-SIBs face full regime + surcharges; community banks get simplified approaches.
Question 145
US enhanced prudential standards under Dodd-Frank for large BHCs (>$100bn) include:
Select an option first.
Correct answer: B — Monthly liquidity stress testing, minimum liquidity buffer, liquidity risk tolerance, and CFP requirement — supplementing the standard LCR.
Explanation: Regulation YY: large BHCs face monthly/daily liquidity stress tests, minimum buffer, tolerance, and CFP.
Question 146
The EU Delegated Act on LCR (Commission Regulation 2015/61):
Select an option first.
Correct answer: B — Provided more detailed specifications for EU-specific HQLA eligibility and run-off rates — adapting the Basel standard to European market structures.
Explanation: EU Delegated Act: Basel LCR adapted for EU market specifics, EU instrument eligibility, and IPS treatment.
Question 147
The SREP assessment of liquidity can result in:
Select an option first.
Correct answer: B — A Specific Liquidity Requirement (SLR) or guidance above Pillar 1 LCR/NSFR minimums — institution-specific add-on.
Explanation: SREP P2 for liquidity: bank-specific add-on requiring LCR above 100% (e.g., 120%) based on risk profile.
Question 148
The resolution authority needs bank liquidity information because:
Select an option first.
Correct answer: B — Resolution planning requires knowing where liquidity is trapped, how critical functions can be maintained, and how intragroup liquidity flows during resolution.
Explanation: Resolution liquidity planning: where HQLA sits, intragroup flows, how long resolution can be maintained.
Question 149
CCAR in the US primarily addresses which aspect of liquidity:
Select an option first.
Correct answer: B — CCAR includes qualitative capital planning assessment; a separate horizontal liquidity review addresses liquidity resilience more directly.
Explanation: CCAR = capital planning test. Federal Reserve's horizontal liquidity review + Regulation YY address liquidity separately.
Question 150
Deposit guarantee schemes (DGS) reduce bank run risk by:
Select an option first.
Correct answer: B — Reducing the incentive for insured retail depositors to run — their money is safe regardless of bank health.
Explanation: DGS (Diamond-Dybvig): deposit insurance eliminates the bad equilibrium — insured depositors have no incentive to run.
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