Interest Rate Risk Management MCQ: CAIIB BFM Unit 30 Module D

Correct Answer: C. Deregulation. This process reduced controls and allowed interest rates to fluctuate more freely, exposing banks to greater risk from rate changes.

Correct Answer: B. To protect them from ups and downs in interest rates. The core goal is to maintain stability in NII and NIM despite interest rate volatility.

Correct Answer: B. The risk that the bank’s earnings or value will be negatively affected by interest rate changes. It concerns the exposure of the bank’s financial health to unfavorable interest rate movements.

Correct Answer: C. Net Interest Income and the market value of assets and liabilities. Rate changes affect earnings (NII) and the value of assets, liabilities, and even off-balance-sheet items.

Correct Answer: C. Their value decreases. When new bonds or loans offer higher interest rates, existing fixed-rate assets with lower rates become less attractive, reducing their market value.

Correct Answer: B. Their value increases. When new loans or bonds offer lower rates, existing fixed-rate assets with higher rates become more valuable.

Correct Answer: B. The dates when assets and liabilities mature or their rates change do not match. Mismatches in timing for repricing or maturity between assets and liabilities create exposure to rate changes.

Correct Answer: B. Net Interest Income divided by Average Earning Assets. NIM measures how effectively a bank uses its earning assets to generate net interest income.

Correct Answer: C. Gap or Mismatch Risk. This risk specifically relates to the timing differences in repricing between assets and liabilities.

Correct Answer: B. The difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) in a specific period. The Gap measures the mismatch in rate sensitivity within a defined timeframe.

Correct Answer: B. It is likely to benefit. Being ‘Asset-Sensitive’ (RSA > RSL) means that when rates rise, the interest earned on assets increases more quickly or by a larger amount than the interest paid on liabilities, boosting NII.

Correct Answer: C. It is likely to be hurt. Being ‘Liability-Sensitive’ (RSL > RSA) means that when rates rise, the interest paid on liabilities increases more quickly or by a larger amount than the interest earned on assets, reducing NII.

Correct Answer: B. The risk that interest rates on different assets and liabilities change by different amounts. Even if repricing dates match, the amount of change in rates (e.g., loan rate vs. deposit rate) can differ, creating risk.

Correct Answer: B. When a bank’s total interest-earning assets are different from its total interest-paying liabilities. This risk arises simply from the different total amounts subject to earning or paying interest.

Correct Answer: D. Embedded Option Risk. This risk arises because options held by customers (like prepayment or early withdrawal) can alter the expected cash flows and expose the bank to rate changes.

Correct Answer: C. Borrowers prepaying their existing loans. When rates fall, borrowers often refinance or prepay higher-rate loans, causing the bank to lose that interest income and potentially have to reinvest at lower rates.

Correct Answer: B. The risk arising from changes in the shape or slope of the yield curve. Changes in the relationship between short-term and long-term interest rates can affect bank profitability differently.

Correct Answer: B. Price Risk. This is the risk that the market value (price) of an instrument decreases due to interest rate changes, leading to a loss if sold before maturity.

Correct Answer: B. Long-term fixed-rate bonds. The market value of longer-term, fixed-rate instruments is more sensitive to changes in prevailing interest rates compared to short-term or floating-rate ones.

Correct Answer: B. The risk that future cash flows received by the bank must be reinvested at lower interest rates. This affects the return earned on principal repayments or coupon payments received over time.

Correct Answer: C. The long-term Economic Value. Interest rate risk impacts both immediate earnings and the overall present value of the bank’s future cash flows (its economic value).

Correct Answer: B. The impact of rate changes on the net present value of the bank’s assets, liabilities, and OBS positions. This perspective takes a long-term view by looking at the present value of all future cash flows.

Correct Answer: C. Gap Analysis. Simpler methods like Gap Analysis are mainly used to estimate the effect of interest rate changes on earnings (NII) by looking at repricing gaps.

Correct Answer: B. The impact on the bank’s economic value and a wider range of risks. Duration and Simulation look at the change in the net present value (economic value) and can incorporate basis risk, option risk, etc.

Correct Answer: B. Grouping Rate Sensitive Assets (RSA) and Liabilities (RSL) into time bands. Assets and liabilities are categorized based on when they next reprice or mature.

Correct Answer: B. Rate Sensitive Assets (RSA) minus Rate Sensitive Liabilities (RSL). The gap is the difference between assets and liabilities that will reprice within that period.

Correct Answer: B. NII may fall. With a positive gap, more assets reprice downwards than liabilities when rates fall, potentially reducing NII.

Correct Answer: C. It ignores basis risk and does not handle options well. Gap analysis simplifies assumptions and overlooks differences in rate changes (basis risk) and customer behavior (options).

Correct Answer: B. The approximate percentage change in an asset’s market value for a 1% change in interest rates. Duration is a measure of price sensitivity to interest rate changes.

Correct Answer: B. To assess the exposure of the bank’s economic value. Duration focuses on how the market value (economic value) of assets and liabilities changes with interest rates.

Correct Answer: C. Embedded options in financial instruments. Effective duration tries to account for how options (like prepayment) cause prices to change non-linearly with interest rates.

Correct Answer: C. Simulation Approaches. Simulations use models to project how various possible interest rate scenarios would affect earnings and economic value.

Correct Answer: B. Static uses the current balance sheet; Dynamic includes assumptions about future business. Dynamic simulations are more forward-looking, incorporating expected changes in the business.

Correct Answer: C. Uncertainty about behavioral patterns beyond contract terms. Predicting when customers will exercise options (like prepayment) or how non-maturity deposits will behave adds complexity.

Correct Answer: B. Adjusting the balance sheet structure (managing RSA-RSL gap). Banks actively manage the mix and timing of their assets and liabilities to control the gap and risk exposure.

Correct Answer: C. Shorten the duration of its assets or increase floating-rate lending. This makes the asset side more sensitive to rate changes (or less sensitive to falling rates compared to liabilities), thus increasing asset sensitivity relative to liability sensitivity.

Correct Answer: B. Using derivatives like Interest Rate Swaps or Options. Financial derivatives can be used to offset or transfer interest rate risk.

Correct Answer: A. Perfect matching is usually impractical or too costly. Achieving a zero gap or perfect match across all time bands is often not feasible or desirable for normal banking operations.

Correct Answer: C. The Board of Directors. The Board has ultimate responsibility for oversight and approving the high-level strategy and risk appetite for IRR.

Correct Answer: B. Interest Rate Risk in the Banking Book. This refers specifically to the interest rate risk associated with items held in the bank’s banking book (non-trading assets and liabilities).

Correct Answer: C. Economic Value of Equity (EVE) and Net Interest Income (NII). RBI requires banks to evaluate IRRBB’s potential impact on both the long-term economic value and short-term earnings.

Correct Answer: C. Six prescribed standard interest rate shock scenarios. RBI mandates the use of specific, standardized shock scenarios in addition to the bank’s internal modeling.

Correct Answer: C. Non-Maturity Deposits (NMDs) like savings accounts. Because these deposits don’t have a fixed maturity date, modeling their interest rate sensitivity requires specific assumptions guided by RBI.

Correct Answer: B. Having clear lines of responsibility and independent risk functions. Clear roles and separation of duties, especially ensuring the risk management function is independent, are vital for effective control.

Correct Answer: C. Basel III Pillar 2. RBI aligns its IRRBB requirements with the Basel III framework, specifically under Pillar 2 which covers supervisory review and risk management practices beyond minimum capital requirements.