FINAN 4300 Problem Set 14

The Net Stable Funding Ratio (NSFR) requires banks to maintain stable funding at least equal to 80% of required funding over a one -year horizon.

False

The Net Stable Funding Ratio (NSFR) minimum is 100%, not 80%. Banks must maintain available stable funding at least equal to 100% of required stable funding over a one -year horizon to reduce reliance on unstable short -term funding.

A bank that is liability -sensitive will see its net interest margin rise when market interest rates increase.

True

A liability -sensitive bank has more rate -sensitive liabilities than assets, so when rates rise, interest expense rises faster than interest income. Net interest margin falls, not rises

Interest rate swaps are mainly used to speculate on future rate movements rather than to hedge risk.

False

The main role of interest rate swaps in banking is hedging mismatches between assets and liabilities. While they can be used for speculation, regulators expect banks to use them prudently to reduce exposure to adverse rate movements.

A positive gap (rate -sensitive assets exceed rate -sensitive liabilities) exposes a bank to declining rates.

True

With a positive gap, more assets than liabilities reprice in the short term. If rates decline, asset yields fall more than liability costs, reducing net interest income

If the yield curve flattens, the spread between long -term and short -term interest rates narrows, reducing banks typical profitability from maturity transformation

True

A flattening yield curve reduces the difference between long -term and short - term rates. Since banks borrow short and lend long, this narrows spreads and compresses profitability from maturity transformation

Selling loans into the secondary market is a tool for both liquidity management and interest rate risk reduction.

True

Selling loans generates immediate cash and removes interest -sensitive assets from the balance sheet. This helps both liquidity management and reduces exposure to rate changes on those loans.

A bank with a large proportion of fixed -rate mortgages funded by short -term deposits is more vulnerable to interest rate risk than a bank with floating -rate loans.

True

Funding long -term fixed -rate mortgages with short -term deposits exposes the bank to repricing risk. If deposits reprice upward faster than fixed -rate loan yields, margins are squeezed, making this structure riskier than floating -rate lending.

Derivatives like caps, floors, and collars allow banks to manage interest rate risk by setting boundaries on how much rates can affect them.

True

Derivatives like caps, floors, and collars establish boundaries for rate movements. They act like insurance by limiting how much rising or falling rates affect earnings or funding costs.

If a bank s Interest Sensitivity Gap Ratio equals 1.0, it means the bank is fully immunized against changes in interest rates.

False

An Interest Sensitivity Gap Ratio of 1.0 means rate -sensitive assets equal liabilities in the short term, reducing exposure to small rate changes. But it does not fully immunize the bank, as basis risk, yield curve shifts, and longer -term mismatche s can still affect performance.

When interest rates rise, the market value of a bank s fixed -income securities portfolio generally declines, creating potential economic value risk even if short - term earnings appear stable

True

Rising interest rates reduce the market value of fixed -income securities because discounting future cash flows at higher rates lowers their present value. This creates an economic value risk to the bank s capital position even if reported earnings a ppear stable.

Dynamic gap analysis is superior to static gap analysis because it recognizes that the timing of repricing changes over time and that management actions can alter the gap profile.

True

Dynamic gap analysis projects how repricing gaps evolve over multiple periods and incorporates management responses, making it more realistic than static gap analysis. Static gap provides only a one -period snapshot, which can misstate long-term expo sure

Basis risk arises when assets and liabilities are tied to different reference rates, and those rates do not move in perfect correlation.

True

Basis risk occurs when assets and liabilities are linked to different benchmarks, such as SOFR versus Treasury yields. If those rates do not move together, earnings and balance sheet values may shift unexpectedly even if overall gaps appear balanced.

Customer behavior, such as early loan prepayments or withdrawal of deposits, can significantly alter a bank s actual interest rate exposure compared with what gap reports suggest

True

Behavioral optionality such as mortgage prepayments or deposit withdrawals means actual repricing often differs from contractual terms. Banks must account for these customer -driven behaviors, which can significantly alter interest rate risk exposure

A bank is asset-sensitive if its:

Interest-sensitive assets exceed its interest-sensitive liabilities

An advantage of interest rate swaps is that:

• It can help protect from interest rate fluctuations

• It can help achieve lower borrowing costs

• It can help closely match the maturities of assets and liabilities

• It can help transform actual cash flows to more closely match desired cash flow patterns

What will be the result to Net Interest Margin if the yield curve is upward sloping?

Positive

What type of yield curve is characterized by short-term rates being higher than longterm rates?

Abnormal or inverted curve

The issuance of loans to borrowers is considered a:

Cash outflow

Which of the following would be considered a risk mitigation tool that could be used to minimize interest rate risk?

Loan sale

What is the primary comparative interest rate metric used to manage interest rate performance?

Interest Sensitivity Gap Ratio

Which of the following best describes a liability-sensitive bank?

It has more rate-sensitive liabilities than rate-sensitive assets

Which of the following is an example of using derivatives to hedge interest rate risk?

Entering into a swap to pay fixed and receive floating when the bank has many floating-rate loans

Changes in interest rates can affect not just earnings but also the market value of a bank’s equity. This long-term perspective on interest rate risk is best captured by analyzing:

Economic value of equity (EVE)

Which measure is most focused on short-term earnings sensitivity rather than long term capital value?

Earnings-at-Risk

Which of the following best illustrates optionality embedded in a bank’s balance sheet?

Borrowers refinancing fixed-rate mortgages when rates fall

Which of the following governance tools is most commonly used by bank boards and ALCOs (Asset-Liability Committees) to control interest rate risk?

Setting internal gap limits and running stress scenarios