FRM Part 2 Schweser Notes 2023 Book 4

Readings and Learning Objectives Reading 59 Liquidity Risk Exam Focus Module 59.1: Trading Liquidity Risk Module 59.2: Funding Liquidity Risk Case Studies Liquidity Risk Ratios Module 59.3: Liquidity Black Holes and Positive Feedback Trading Key Concepts LO 59.a LO 59.b LO 59.c LO 59.d Answer Key for Module Quizzes Reading 60 Liquidity and Leverage Exam Focus Module 60.1: Sources of Liquidity Risk, Liquidity Transformation, and Systematic Funding Sources of Liquidity Risk Liquidity Transformation by Banks Structured Credit Products and Off-Balance Sheet Vehicles Systematic Funding Liquidity Risk Module 60.2: The Collateral Market and Leverage Economics of the Collateral Market Leverage Ratio and Leverage Effect Margin Loans and Leverage Short Positions and Leverage Derivatives and Leverage Module 60.3: Funding and Transactions, Liquidity Risk, and Transactions Cost Sources of Transactions Liquidity Risk Transactions Cost Adjusting VaR for Position Liquidity Measuring Market Liquidity Funding Liquidity Risk Management Key Concepts LO 60.a LO 60.b LO 60.c LO 60.d LO 60.e LO 60.f LO 60.g Answer Key for Module Quizzes Reading 61 Early Warning Indicators Exam Focus Module 61.1: Early Warning Indicators for Liquidity Risk Management EWI Characteristics Framework Measures Normal and Stressed States Different Time Horizons EWI Applications Escalation Reporting Integrated Systems Thresholds Industry Practices EWI Guidelines OCC (2012) Guidelines BCBS (2008) Guidelines BCBS (2012) Guidelines Federal Reserve (Supervision and Regulation [SR] 10-6) Guidelines Key Concepts LO 61.a LO 61.b LO 61.c AnsweR Key for Module Quizzes Reading 62 The Investment Function in Financial-Services Management Exam Focus Module 62.1: Money Market and Capital Market Instruments Money Market Investments Capital Market Investments More Recently Developed Investment Instruments Module 62.2: Investment Security Selection and Risks Expected Rate of Return Tax Exposure Interest Rate Risk Credit Risk Business Risk Liquidity Risk Call Risk Prepayment Risk Inflation Risk Pledging Requirements Module 62.3: Investment Maturity Strategies and Maturity Management Tools Investment Maturity Strategies Ladder (Spaced-Maturity) Policy Front-End Load Maturity Approach Back-End Load Maturity Approach Barbell Strategy Rate Expectations Approach Maturity Management Tools The Yield Curve Interest Rate Forecasts Risk-Return Trade-Offs Carry Trade Riding the Yield Curve Duration Portfolio Immunization With Duration Key Concepts LO 62.a LO 62.b LO 62.c Answer Key for Module Quizzes Reading 63 Liquidity and Reserves Management: Strategies and Policies Exam Focus Module 63.1: Net Liquidity and Strategies Asset Liquidity Management Liability (Borrowed Liquidity) Management Balanced Liquidity Management Module 63.2: Bank Liquidity Needs Sources and Uses of Funds Approach Structure of Funds Approach Liquidity Indicator Approach Market Signals/Discipline Approach Module 63.3: Legal Reserves and Sources of Reserves Key Concepts LO 63.a LO 63.b LO 63.c LO 63.d LO 63.e Answer Key for Module Quizzes Reading 64 Intraday Liquidity Risk Management Exam Focus Module 64.1: Uses and Sources of Intraday Liquidity Uses of Intraday Liquidity Outgoing Wire Transfers Settlements at Payment Clearing and Settlement (PCS) Systems Funding of Nostro Accounts Collateral Pledging Asset Purchases/Funding Sources of Intraday Liquidity Cash Balances Incoming Funds Flow Intraday Credit Liquid Assets Overnight Borrowings Other Term Funding Summary Module 64.2: Managing and Measuring Intraday Liquidity Risk Active Risk Management Integration With Risk Governance Risk Assessment Risk Measurement and Monitoring Tracking Intraday Flows and Monitoring Risk Levels Methods for Tracking Intraday Flows Monitoring Risk Levels Key Concepts LO 64.a LO 64.b LO 64.c Answer Key for Module Quizzes Reading 65 Monitoring Liquidity Exam Focus Module 65.1: Cash Flow Types and Liquidity Options Deterministic and Stochastic Cash Flows Liquidity Options Module 65.2: Liquidity Risks, Cash Flows, and Capacity Module 65.3: Managing Assets for Liquidity Key Concepts LO 65.a LO 65.b LO 65.c LO 65.d LO 65.e Answer Key for Module Quizzes Reading 66 The Failure Mechanics of Dealer Banks Exam Focus Module 66.1: Functions of Dealer Banks Dealer Bank Markets Diseconomies of Scope Module 66.2: Liquidity Concerns for Dealer Banks and Risk Policy Measures Liquidity Concerns for Dealer Banks Policies to Alleviate Dealer Bank Risks Key Concepts LO 66.a LO 66.b LO 66.c Answer Key for Module Quizzes Reading 67 Liquidity Stress Testing Exam Focus Module 67.1: Types of Liquidity and Contingent Liquidity Estimating Contingent Liquidity Module 67.2: Liquidity Stress Test Design Issues Scope Scenario Development Historical Scenarios Hypothetical Scenarios Reverse Liquidity Stress Tests Assumptions Investment Portfolio Haircuts Deposit Outflows Unsecured Wholesale Funding Collateral Requirements Other Contingent Liabilities Business Reduction Outputs Governance Integration With Other Risk Models Key Concepts LO 67.a LO 67.b LO 67.c Answer Key for Module Quizzes Reading 68 Liquidity Risk Reporting and Stress Testing Exam Focus Module 68.1: Liquidity Risk Reports Best Practices in Liquidity Reporting Interpreting Liquidity Risk Reports Deposit Tracker Report Daily Liquidity Report Funding Maturity Gap (Mismatch) Report Funding Concentration Report Undrawn Commitment Report Liability Profile Wholesale Pricing and Volume Summary Liquidity Report MI Module 68.2: Liquidity Stress Tests Key Concepts LO 68.a LO 68.b LO 68.c Answer Key for Module Quizzes Reading 69 Contingency Funding Planning Exam Focus Module 69.1: Contingency Funding Planning Module 69.2: Components of a Contingency Funding Plan Governance and Oversight Stakeholder Involvement, Roles, and Responsibilities Communication and Coordination Policies and Procedures Testing and Readiness Assessment Scenarios and Liquidity Gap Analysis Contingent Actions Monitoring and Escalation Market and Business Measures Liquidity Health Measures Escalation Levels Data and Reporting Key Concepts LO 69.a LO 69.b LO 69.c Answer Key for Module Quizzes Reading 70 Managing and Pricing Deposit Services Exam Focus Module 70.1: Transaction and Nontransaction Deposit Types Transaction (Demand) Deposits Nontransaction (Savings or Thrift) Deposits Module 70.2: Methods of Pricing Deposits Deposit Account Costs Deposit Services Pricing Cost-Plus Pricing of Deposit Services Marginal Cost Method to Set Deposit Rates Conditional Pricing Module 70.3: Challenges to Offering Deposit Accounts Deposit Insurance FDIC Insurance Premiums Bank Disclosures Overdraft Protection Basic (Lifeline) Banking Key Concepts LO 70.a LO 70.b LO 70.c Answer Key for Module Quizzes Reading 71 Managing Nondeposit Liabilities Exam Focus Module 71.1: Nondeposit Liabilities and Available Funds Gap Sources of Nondeposit Liabilities Available Funds Gap Module 71.2: Choice and Cost of Nondeposit Sources of Funds Choice of Funds Cost of Funds Historical Average Cost Approach Pooled Funds Approach Key Concepts LO 71.a LO 71.b LO 71.c LO 71.d Answer Key for Module Quizzes Reading 72 Repurchase Agreements and Financing Exam Focus Module 72.1: Mechanics of Repos, Repo Motivations, and Counterparty and Liquidity Risk Mechanics of Repurchase Agreements Borrowers in Repos Bond Financing Liquidity Management Lenders in Repos Cash Management (Repos as Investment Vehicles) Short Position Financing (Repos as Financing Vehicles) Counterparty Risk and Liquidity Risk Module 72.2: The Credit Crisis, Collateral, and Special Spreads Repos During the Credit Crisis Repos and Lehman Brothers Repos and Bear Stearns Collateral in Repo Transactions General Collateral Special Collateral Special Spreads and the Auction Cycle Special Spreads and Rate Levels Key Concepts LO 72.a LO 72.b LO 72.c LO 72.d LO 72.e LO 72.f LO 72.g Answer Key for Module Quizzes Reading 73 Liquidity Transfer Pricing: A Guide to Better Practice Exam Focus Module 73.1: Best Practices and Challenges for Liquidity Transfer Pricing LTP Process Best Practices for Governing the LTP Process Challenges of Implementing the LTP Process Module 73.2: Approaches for Liquidity Transfer Pricing and Contingent Liquidity Risk Pricing Zero-Cost Approach Pooled Average Cost of Funds Approach Separate Average Costs of Funds Approach Marginal Cost of Funds Approach Applying the Matched-Maturity Marginal Cost Approach in Practice Contingent Liquidity Risk Pricing Process Key Concepts LO 73.a LO 73.b LO 73.c LO 73.d Answer Key for Module Quizzes Reading 74 The US Dollar Shortage in Global Banking and the International Policy Response Exam Focus Module 74.1: Global Bank Balance Sheets and Vulnerabilities Global Balance Sheets and Funding Risk Vulnerabilities in Balance Sheets The Importance of Banks’ Foreign Offices Global Balance Sheet Expansion and Cross-Currency Funding Maturity Mismatches Across Balance Sheets Module 74.2: U.S. Dollar Shortage and International Policy Response Causes of the 2007–2009 U.S. Dollar Shortage International Policy Response by Central Banks Key Concepts LO 74.a LO 74.b LO 74.c Answer Key for Module Quizzes Reading 75 Covered Interest Parity Lost: Understanding the Cross-Currency Basis Exam Focus Module 75.1: Covered Interest Parity Violations Foreign Exchange (FX) Swaps Cross-Currency Basis Swaps Why the Basis Opens Up: Demand for Currency Hedges Why the Basis Does Not Close: Limits to Arbitrage Key Concepts LO 75.a LO 75.b LO 75.c Answer Key for Module Quizzes Reading 76 Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques Exam Focus Module 76.1: Interest-Sensitive Gap Management Asset-Liability Management Strategies Managing Interest Rate Risk Net Interest Margin and Gap Management Module 76.2: Duration Gap Management Gap Management Limitations Limitations of Interest-Sensitive Gap Management Limitations of Duration Gap Management Key Concepts LO 76.a LO 76.b LO 76.c LO 76.d Answer Key for Module Quizzes Reading 77 Illiquid Assets Exam Focus Module 77.1: Illiquid Markets, Market Imperfections, Biases, and Unsmoothing Illiquid Asset Markets Most Asset Classes Are Illiquid Markets for Illiquid Assets Are Large Investor Holdings of Illiquid Assets Liquidity Can Dry Up Market Imperfections Illiquid Asset Return Biases Survivorship Bias Sample Selection Bias Infrequent Trading Module 77.2: Illiquidity Risk Premiums and Portfolio Allocation to Illiquid Assets Illiquidity Risk Premiums Illiquidity Risk Premiums Across Asset Classes Illiquidity Risk Premiums Within Asset Classes Illiquidity Effects in U.S. Treasury Markets Illiquidity Effects in Corporate Bond Markets Illiquidity Effects in Equity Markets Secondary Markets for Private Equity and Hedge Funds Portfolio Allocation to Illiquid Assets Asset Allocation to Illiquid Asset Classes with Transaction Costs Asset Allocation to Illiquid Asset Classes with Infrequent Trading Key Concepts LO 77.a LO 77.b LO 77.c LO 77.d LO 77.e LO 77.f Answer Key for Module Quizzes Formulas Reading 59 Reading 60 Reading 62 Reading 63 Reading 65 Reading 67 Reading 70 Reading 71 Reading 73 Reading 75 Reading 76 Index