Liquidity and Treasury Risk Measurement and Management: FRM® Part II
It is 15% of the 2026 Part II exam. 65 learning outcomes across 17 learning modules.
Liquidity Risk
- Show why trading liquidity risk matters and work out its size using the cost of liquidating a position and liquidity-adjusted VaR (LVaR).
- Give instances of funding liquidity risk and the funding sources involved, and draw out what the Northern Rock, Ashanti Goldfields and Metallgesellschaft episodes taught.
- Weigh up the liquidity ratios introduced under Basel III together with the BIS principles that define sound management of liquidity risk.
- Show how liquidity black holes come about, and name the forces behind trading that reinforces price moves (positive feedback trading).
Liquidity and Leverage
- Tell apart the different origins of liquidity risk and set out the particular difficulties that various kinds of financial institution meet when managing it.
- Outline how a fractional reserve bank runs asset-liability management, including how it carries out liquidity transformation.
- Contrast the transaction types found in collateral markets and account for the risks that these transactions can create.
- Set out how leverage shapes a firm's returns, including the leverage effect, and show how different transaction types alter leverage and the balance sheet.
- Lay out and compare ways of measuring and managing two exposures: funding liquidity risk, and the risk of being unable to transact at fair prices.
- For a trade, derive the spread risk factor and the cost expected on execution; for a position sold down across multiple days, compute the resulting liquidity adjustment applied to VaR.
- Examine how the various forms of liquidity risk feed into one another and show how liquidity events can heighten systemic risk.
Early Warning Indicators
- Judge what features make Early Warning Indicator (EWI) measures sound.
- Pick out the EWI guidance issued by banking regulators and supervisors, namely the OCC, the BCBS and the Federal Reserve.
- Examine how EWIs are put to use within a bank's process for managing liquidity risk.
The Investment Function in Financial-Services Management
- Set money market and capital market instruments side by side and weigh their strengths and weaknesses.
- Identify and examine the considerations that shape which investment securities a bank selects.
- Use the yield curve and duration to apply maturity strategies and the tools for managing maturity in an investment portfolio.
Liquidity and Reserves Management: Strategies and Policies
- Compute the net liquidity position of a bank and show which factors push its liquidity supply and liquidity demand up or down.
- Contrast the approaches open to a bank for covering a need for extra liquidity.
- Forecast the liquidity a bank will require using three techniques, namely the sources-and-uses-of-funds approach, the structure-of-funds approach and liquidity indicators.
Intraday Liquidity Risk Management
- Pinpoint and account for where intraday liquidity is drawn from and what it is needed for.
- Examine how responsibility for intraday liquidity risk management is organised and overseen.
- Distinguish the techniques for following intraday flows from those for keeping watch on risk levels.
Monitoring Liquidity
- Distinguish cash flows that are deterministic from those that are stochastic and give examples of both.
- Characterise liquidity options with examples, and show how they affect a bank's liquidity position and the way it manages liquidity.
- Cash flow at risk, expected liquidity, funding cost risk, liquidity generation capacity and liquidity risk itself each need to be understood and then used in practical analysis.
- Interpret how expected cash flows, and their running cumulative totals, are spread across maturities.
- Examine how transactions in available assets change cash flows and the capacity to generate liquidity.
The Failure Mechanics of Dealer Banks
- Set the main business lines of dealer banks side by side, noting the risk factors each line carries.
- Recognise the scenarios in which a dealer bank may run into a liquidity crisis, and describe the actions that can limit the danger.
- Evaluate regulatory and policy steps that might lower the risks that big dealer banks pose to themselves individually and to the wider system.
Liquidity Stress Testing
- Distinguish among funding, operational, strategic, contingent and restricted liquidity as separate categories.
- Use the liquid asset buffer as the basis for estimating a firm's contingent liquidity.
- Examine the design choices in a liquidity stress test, including its scope, scenario building, assumptions, outputs, governance and how it fits with other risk models.
Liquidity Risk Reporting and Stress Testing
- Describe good practice when a bank communicates where its liquidity stands.
- Contrast the varieties of liquidity risk report and read their results.
- Walk through how a liquidity stress test is reported and interpret the resulting report.
Contingency Funding Planning
- Discuss the link between planning for contingent funding and the results of liquidity stress tests.
- Describe what good practice looks like when building a robust contingency funding plan.
- Appraise the building blocks of a contingency funding plan, covering oversight and governance, scenario work including liquidity gap analysis, actions to take if needed, escalation and monitoring, plus the supporting data and reports.
Managing Non-Deposit Liabilities
- Tell apart the different ways a bank can raise funds other than deposits.
- Explain the available funds gap and work out its value.
- Examine what influences a bank's selection among non-deposit funding sources.
- Compute a bank's all-in funding cost twice over, once by the pooled-funds method and once by averaging historical costs.
Repurchase Agreements and Financing
- Lay out how repurchase agreements (repos) operate and work out the settlement amount of a repo.
- Examine the usual reasons for entering repos, among them cash management and liquidity management.
- Show how repo use can give rise to counterparty risk and to liquidity risk.
- Evaluate how repo dealings contributed to Lehman Brothers and Bear Stearns collapsing in the 2007-2009 crisis.
- Compare repos backed by general collateral against those backed by special collateral.
- Recognise the traits of special spreads and trace how a US Treasury issue's special spread tends to evolve from one auction to the next.
- Work out the financing benefit gained when a bond that trades special is used in a repo.
Liquidity Transfer Pricing: A Guide to Better Practice
- Discuss the workings of liquidity transfer pricing (LTP), and name the leading practices for its governance and rollout.
- Examine the difficulties banks can face when putting LTP into practice.
- Contrast the zero-cost, average-cost and matched-maturity marginal-cost routes to setting internal liquidity transfer prices.
- Outline how contingent liquidity risk is priced and work out what that risk costs.
The US Dollar Shortage in Global Banking and the International Policy Response
- Name the factors that produced the scarcity of US dollars during the Great Financial Crisis.
- Assess how important it is to examine maturity and currency mismatches in the combined balance sheets of the entities within a consolidated group.
- Outline how central banks around the world responded to the dollar shortage and weigh up how well that response worked.
Covered Interest Parity Lost: Understanding the Cross-Currency Basis
- Contrast how FX swaps and cross-currency swaps work.
- Pick out the main drivers of the cross-currency swap basis.
- Evaluate the reasons that covered interest rate parity stopped holding in the wake of the 2008 financial crisis.
Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques
- Discuss the ways a bank can protect itself against interest rate risk through asset-liability management strategies.
- Explain the mechanics of interest-sensitive gap management and use that strategy to get the highest possible net interest margin for a bank.
- Outline duration gap management and use it to safeguard a bank's net worth.
- Point out the drawbacks of managing interest rate exposure through rate-sensitivity gaps and through duration gaps.
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