Module: | MODULE D: BALANCE SHEET MANAGEMENT
Q579: Consider the following statements regarding Repricing Schedules and the execution of Static Gap Analysis:
1. Traditional Gap Analysis measures the static difference between rate-sensitive assets and rate-sensitive liabilities over predefined time bands, effectively assessing the short-term earnings risk for the institution.
2. A positive or asset-sensitive gap occurs when rate-sensitive assets exceed rate-sensitive liabilities, explicitly meaning a decrease in market interest rates will cause a direct decline in Net Interest Income.
3. The Interest Rate Sensitive Ratio is calculated mathematically as Rate Sensitive Assets divided by Rate Sensitive Liabilities, where a ratio of exactly 1.0 indicates a perfectly matched book with no net gap exposure.
4. A fundamental limitation of Static Gap Analysis is the assumption that all assets and liabilities mature or reprice simultaneously within the selected time bucket, thereby capturing intra-bucket basis risk perfectly.
2. A positive or asset-sensitive gap occurs when rate-sensitive assets exceed rate-sensitive liabilities, explicitly meaning a decrease in market interest rates will cause a direct decline in Net Interest Income.
3. The Interest Rate Sensitive Ratio is calculated mathematically as Rate Sensitive Assets divided by Rate Sensitive Liabilities, where a ratio of exactly 1.0 indicates a perfectly matched book with no net gap exposure.
4. A fundamental limitation of Static Gap Analysis is the assumption that all assets and liabilities mature or reprice simultaneously within the selected time bucket, thereby capturing intra-bucket basis risk perfectly.
✅ Correct Answer: A
Traditional Gap Analysis (TGA) is the foundational tool for measuring Repricing Risk.
It works by slotting all Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) into standardized maturity or repricing time buckets (e.g., 1-28 days, 29-90 days). The net difference in each bucket is the "Gap." If RSA > RSL, the bank has a positive gap (asset-sensitive). In this state, falling interest rates are dangerous because more assets will reprice downward than liabilities, shrinking the Net Interest Income (NII). Conversely, if RSL > RSA, the bank has a negative gap (liability-sensitive), and rising rates will crush profitability as borrowing costs surge faster than asset yields.
The relative exposure is also measured using the Interest Rate Sensitive (IRS) Ratio (RSA/RSL); a target ratio of 1.0 implies perfect neutralization in that time band.
However, TGA suffers from a massive structural flaw: it assumes all cash flows within a specific time bucket mature or reprice at the exact same moment.
Because it aggregates data, it completely ignores "intra-bucket basis risk"—the reality that an asset might reprice on day 2 of the bucket while the liability reprices on day 27.
A: Only 1, 2, and 3 is the correct answer.
These statements accurately detail the mechanics of TGA, the dynamics of a positive gap, and the IRS ratio, while correctly identifying that statement 4 is fundamentally false.
B: The combination of Only 2 and 4 is incorrect because it includes statement 4, which falsely claims TGA captures intra-bucket basis risk perfectly, when in reality, ignoring intra-bucket risk is its primary weakness.
C: The combination of Only 1, 3, and 4 is incorrect because it validates the false premise in statement 4 regarding intra-bucket basis risk, and excludes the correct operational definition of an asset-sensitive gap in statement 2.
D: All 1, 2, 3, and 4 is incorrect.
Statement 4 acts as a deliberate distractor.
Static Gap Analysis absolutely fails to capture intra-bucket basis risk; this is the primary reason banks must deploy more advanced dynamic simulation models.
It works by slotting all Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) into standardized maturity or repricing time buckets (e.g., 1-28 days, 29-90 days). The net difference in each bucket is the "Gap." If RSA > RSL, the bank has a positive gap (asset-sensitive). In this state, falling interest rates are dangerous because more assets will reprice downward than liabilities, shrinking the Net Interest Income (NII). Conversely, if RSL > RSA, the bank has a negative gap (liability-sensitive), and rising rates will crush profitability as borrowing costs surge faster than asset yields.
The relative exposure is also measured using the Interest Rate Sensitive (IRS) Ratio (RSA/RSL); a target ratio of 1.0 implies perfect neutralization in that time band.
However, TGA suffers from a massive structural flaw: it assumes all cash flows within a specific time bucket mature or reprice at the exact same moment.
Because it aggregates data, it completely ignores "intra-bucket basis risk"—the reality that an asset might reprice on day 2 of the bucket while the liability reprices on day 27.
A: Only 1, 2, and 3 is the correct answer.
These statements accurately detail the mechanics of TGA, the dynamics of a positive gap, and the IRS ratio, while correctly identifying that statement 4 is fundamentally false.
B: The combination of Only 2 and 4 is incorrect because it includes statement 4, which falsely claims TGA captures intra-bucket basis risk perfectly, when in reality, ignoring intra-bucket risk is its primary weakness.
C: The combination of Only 1, 3, and 4 is incorrect because it validates the false premise in statement 4 regarding intra-bucket basis risk, and excludes the correct operational definition of an asset-sensitive gap in statement 2.
D: All 1, 2, 3, and 4 is incorrect.
Statement 4 acts as a deliberate distractor.
Static Gap Analysis absolutely fails to capture intra-bucket basis risk; this is the primary reason banks must deploy more advanced dynamic simulation models.