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Interpret how expected cash flows, and their running cumulative totals, are spread across maturities.

FRM® Part II · Liquidity and Treasury Risk Measurement and Management · Monitoring Liquidity · FRM2.LTR.7.d

The idea

A liquidity maturity ladder allocates expected cash inflows and outflows to time buckets such as overnight to one week, one week to one month, one to three months and so on. The net flow of a bucket is inflows minus outflows within that bucket only. The cumulative figure is the running sum of net flows from today through the end of that bucket, and it is the amount of funding or surplus that the bank has built up by that date. The largest cumulative deficit, not the last cumulative value, sets the funding that must be available, because the bank must survive every intermediate date. A positive flow in a later bucket only repays the deficit gradually and does not cure the earlier gap. Consistent negative cumulative flows at the short end signal funding of long assets with short liabilities.

A practice question

From the question bank, with the reason each wrong option is wrong.

In a liquidity maturity ladder, the cumulative net cash flow shown for the one-month bucket represents:

  1. The sum of expected net cash flows from today through the end of the one-month bucket - correct
  2. The net cash flow falling only inside the one-month bucketWhy not: Describes the net flow for the bucket, not the running total.
  3. The average of the net flows across all bucketsWhy not: Averages the buckets, which has no meaning as a funding position.
  4. The sum of expected inflows through one month, ignoring outflowsWhy not: Counts only inflows, so it cannot show a funding deficit.

Cumulative net cash flow is the running sum of bucket net flows. It shows the funding built up, or needed, by that date.

A harder one

On a ladder, the net flow for the 1 to 3 month bucket is +50, yet the cumulative net position at three months is -30 (the one-month cumulative position was -80). Which interpretation is correct?

  1. The bank is in surplus for that bucket, so no funding is needed through three monthsWhy not: Looks at the bucket flow alone and ignores the deficit carried forward in the cumulative figure.
  2. A cumulative shortfall of 30 remains at three months and has to be funded; the inflow only reduced the earlier deficit of 80 - correct
  3. The shortfall of 30 arises only in that bucket and disappears in the next, so it can be ignoredWhy not: Treats a cumulative deficit as bucket-specific; it persists until later inflows offset it.
  4. The cumulative shortfall is 130, because the 50 inflow and the 80 deficit are added in absolute valueWhy not: Adds absolute values and ignores that an inflow offsets part of an earlier outflow.

-80 + 50 = -30. Later inflows reduce but do not erase an earlier gap, and the bank needs funding at every date at which the cumulative figure is negative.

The hardest tier

A bank holds a liquid buffer of USD 60 million. Expected net cash flows by bucket (USD million) are: up to 1 week -25; 1 week to 1 month -40; 1 to 3 months +10; 3 to 6 months -50; 6 to 12 months +70. In which bucket does the buffer plus cumulative flows first turn negative, and by how much?

  1. 1 week to 1 month, deficit of USD 65 millionWhy not: Finds the right bucket but reports the cumulative flow without adding the USD 60 million buffer.
  2. 3 to 6 months, deficit of USD 45 millionWhy not: Looks for the largest deficit and misses that the position turns negative earlier.
  3. 1 week to 1 month, deficit of USD 5 million - correct
  4. Up to 1 week, deficit of USD 25 millionWhy not: Ignores the buffer and reports the first outflow as a deficit.

Cumulative: -25, -65, -55, -105, -35. Adding 60 gives +35, -5, +5, -45, +25. The first negative position is -5 in the one-week to one-month bucket.

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