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2021 FRM Learning Objectives – Part 8

Estimated reading time: 8 minutes

 

Introduction

We present part 8 of the learning outcomes, as prescribed by GARP.

 

Liquidity and Treasury Risk Measurement and Management

This area focuses on methods to measure and manage liquidity and treasury risk.

The broad knowledge points covered in the Liquidity and Treasury Risk Management section include the following:

Liquidity risk principles and metrics

Liquidity portfolio management

Cash-flow modeling, liquidity stress testing, and reporting

Contingency funding plan

Funding models

Funds transfer pricing

Cross-currency funding

Balance sheet management

Asset liquidity

 

Liquidity Risk

Explain and calculate liquidity trading risk via cost of liquidation and liquidity-adjusted VaR (LVaR).

Identify liquidity funding risk, funding sources, and lessons learned from real cases: Northern Rock, Ashanti Goldfields, and Metallgesellschaft.

Evaluate Basel III liquidity risk ratios and BIS principles for sound liquidity risk management.

Explain liquidity black holes and identify the causes of positive feedback trading.

 

Liquidity and Leverage

Differentiate between sources of liquidity risk and describe specific challenges faced by different types of financial institutions in managing liquidity risk.

Summarize the asset-liability management process at a fractional reserve bank.

Compare transactions used in the collateral market.

Explain risks that can arise through collateral market transactions.

Describe the relationship between leverage and a firm’s return profile (including the leverage effect) and distinguish the impact of different types of transactions on a firm’s leverage and balance sheet.

Distinguish methods to measure and manage funding liquidity risk and transactions liquidity risk.

Calculate the expected transactions cost and the spread risk factor for a transaction and calculate the liquidity adjustment to VaR for a position to be liquidated over a number of trading days.

Discuss interactions between different types of liquidity risk and explain how liquidity risk events can increase systemic risk.

 

Early Warning Indicators

Evaluate the characteristics of sound Early Warning Indicators (EWI) measures.

Identify EWI guidelines from banking regulators and supervisors (OCC, BCBS, Federal Reserve).

Discuss the applications of EWIs in the context of the liquidity risk management process.

 

The Investment Function in Financial-Services Management

Compare various money market and capital market instruments and discuss their advantages and disadvantages.

Identify and discuss various factors that affect the choice of investment securities by a bank.

Apply investment maturity strategies and maturity management tools based on the yield curve and duration.

 

Liquidity and Reserves Management: Strategies and Policies

Calculate a bank’s net liquidity position and explain factors that affect the supply and demand of liquidity at a bank.

Compare strategies that a bank can use to meet demands for additional liquidity.

Estimate a bank’s liquidity needs through three methods (sources and uses of funds, structure of funds, and liquidity indicators).

Summarize the process taken by a US bank to calculate its legal reserves.

Differentiate between factors that affect the choice among alternate sources of reserves.

 

Intraday Liquidity Risk Management

Identify and explain the uses and sources of intraday liquidity.

Discuss the governance structure of intraday liquidity risk management.

Differentiate between methods for tracking intraday flows and monitoring risk levels.

 

Monitoring Liquidity

Distinguish between deterministic and stochastic cash flows and provide examples of each.

Describe and provide examples of liquidity options.

Explain the impact of liquidity options on a bank’s liquidity position and its liquidity management process.

Describe and apply the concepts of liquidity risk, funding cost risk, liquidity generation capacity, expected liquidity, and cash flow at risk.

Interpret the term structure of expected cash flows and cumulative cash flows.

Discuss the impact of available asset transactions on cash flows and liquidity generation capacity.

 

The Failure Mechanics of Dealer Banks

Compare and contrast the major lines of business in which dealer banks operate and the risk factors they face in each line of business.

Identify situations that can cause a liquidity crisis at a dealer bank and explain responses that can mitigate these risks.

Assess policy measures that can alleviate firm-specific and systemic risks related to large dealer banks.

 

Liquidity Stress Testing

Differentiate between various types of liquidity, including funding, operational, strategic, contingent, and restricted liquidity.

Estimate contingent liquidity via the liquid asset buffer.

Discuss liquidity stress test design issues such as scope, scenario development, assumptions, outputs, governance, and integration with other risk models.

 

Liquidity Risk Reporting and Stress Testing

Identify best practices for the reporting of a bank’s liquidity position.

Compare and interpret different types of liquidity risk reports.

Explain the process of reporting a liquidity stress test and interpret a liquidity stress test report.

 

Contingency Funding Planning

Discuss the relationship between contingency funding planning and liquidity stress testing.

Evaluate the key design considerations of a sound contingency funding plan.

Assess the key components of a contingency funding plan.

 

Managing and Pricing Deposit Services

Differentiate between the various transaction and non-transaction deposit types.

Compare the different methods used to determine the pricing of deposits and calculate the price of a deposit account using cost-plus, marginal cost, and conditional pricing formulas.

Explain challenges faced by banks that offer deposit accounts, including deposit insurance, disclosures, overdraft protection, and basic (lifeline) banking.

 

Managing Non-deposit Liabilities

Distinguish between the various sources of non-deposit liabilities at a bank.

Describe and calculate the available funds gap.

Discuss factors affecting the choice of non-deposit funding sources.

Calculate overall cost of funds using both the historical average cost approach and the pooled- funds approach.

 

Repurchase Agreements and Financing

Describe the mechanics of repurchase agreements (repos) and calculate the settlement for a repo transaction.

Discuss common motivations for entering into repos, including their use in cash management and liquidity management.

Discuss how counterparty risk and liquidity risk can arise through the use of repo transactions.

Assess the role of repo transactions in the collapses of Lehman Brothers and Bear Stearns during the 2007-2009 financial crisis.

Compare the use of general and special collateral in repo transactions.

Identify the characteristics of special spreads and explain the typical behavior of US Treasury special spreads over an auction cycle.

Calculate the financing advantage of a bond trading special when used in a repo transaction.

 

Liquidity Transfer Pricing: A Guide to Better Practice

Discuss the process of liquidity transfer pricing (LTP) and identify best practices for the governance and implementation of an LTP process.

Discuss challenges that may arise for banks during the implementation of LTP.

Compare the various approaches to liquidity transfer pricing (zero cost, average cost, and matched-maturity marginal cost).

Describe the contingent liquidity risk pricing process and calculate the cost of contingent liquidity risk.

 

The US Dollar Shortage in Global Banking and the International Policy Response

Identify the causes of the US dollar shortage during the Great Financial Crisis.

Evaluate the importance of assessing maturity/currency mismatch across the balance sheets of consolidated entities.

Discuss how central bank swap agreements overcame challenges commonly associated with international lenders of last resort.

 

Covered Interest Parity Lost

Differentiate between the mechanics of foreign exchange (FX) swaps and cross-currency swaps.

Identify key factors that affect the cross-currency swap basis.

Assess the causes of covered interest rate parity violations after the financial crisis of 2008.

 

Risk Management for Changing Interest Rates

Discuss how asset-liability management strategies can help a bank hedge against interest rate risk.

Describe interest-sensitive gap management and apply this strategy to maximize a bank’s net interest margin.

Describe duration gap management and apply this strategy to protect a bank’s net worth.

Discuss the limitations of interest-sensitive gap management and duration gap management.

 

Illiquid Assets

Evaluate the characteristics of illiquid markets.

Examine the relationship between market imperfections and illiquidity.

Assess the impact of biases on reported returns for illiquid assets.

Explain the unsmoothing of returns and its properties.

Compare illiquidity risk premiums across and within asset categories.

Evaluate portfolio choice decisions on the inclusion of illiquid assets.

 

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