Chapter 5 Testbank Solution Manual Financial Institutions Management A Risk Management Approach

Chapter 05 - Testbank
Student: ___________________________________________________________________________
1. Repricing gap refers to the:
A. difference between rate-sensitive assets and rate-sensitive liabilities.
B. sum of rate-sensitive assets and rate-sensitive liabilities.
C. difference between rate-sensitive liabilities and rate-sensitive assets.
D. difference between rate-insensitive assets and rate-insensitive liabilities.
2. The term 'rate-sensitive assets' refers to assets:
A. whose interest rate will be repriced over some future period.
B. with a particularly high interest rate.
C. with a particularly low interest rate.
D. for which demand is highly dependent on the level of interest rates.
3. Which of the following statements is true?
A. APRA requires smaller Australian FIs to use the repricing gap method to estimate interest rate exposures in their
banking book for capital adequacy.
B. Australian FIs are only required to use the repricing gap method if they are listed on an US stock exchange.
C. APRA does not require Australian FIs to use the repricing gap method to estimate interest rate exposures in their
D. Australian FIs are only required to use the repricing gap if they are internationally active.
4. What is spread effect?
A. Periodic cash flow of interest and principal amortisation payments on long-term assets that can be reinvested at
market rates.
B. The effect that a change in the spread between rates on rate sensitive assets and rate sensitive liabilities has on net
interest income as interest rates change.
C. The effect of mismatch of asset and liabilities within a maturity bucket.
D. The premium paid to compensate for the future uncertainty in a security's value.
5. The cumulative gap over the whole balance sheet by definition:
A. must be greater than zero.
B. must be lower than zero.
C. must equal zero.
D. can take any value.
A. A negative gap indicates that a rise in interest rates would lower the bank's net interest income.
B. A positive gap indicates that a rise in interest rates would lower the bank's net interest income.
C. A negative gap indicates that a rise in interest rates would increase the bank's net interest income.
D. None of the listed options are correct.

A. A negative gap indicates that a rise in interest rates would increase the bank's net interest income.
B. A positive gap indicates that a rise in interest rates would increase the bank's net interest income.
C. A positive gap indicates that a fall in interest rates would increase the bank's net interest income.
8. Consider the following repricing buckets and gaps:

Repricing bucket Assets Liabilities Gaps

1 day $000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
What is the annualised change in the bank's future net interest income if the overnight interest rate decreased by 100 basis points?
A. –$700
B. $700
C. –$7000
D. $700



1 day $50 000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
What is the annualised change in the bank's future net interest income if the overnight interest rate increased by 100 basis points?
A. –$700
B. $700
C. –$7000
D. $700



1 day $50 000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
What is the annualised change in the bank's future net interest income if the average rate change for assets and liabilities that can be
repriced within one year is an increase of 100 basis points?
A. $17 000
B. –$17 000
C. $13 000
D. –$13 000



1 day $50 000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
repriced within one year is a decrease of 100 basis points?
A. $17 000
B. –$17 000
C. $13 000
D. –$13 000


Repricing bucket Assets Liabilities Gaps Cumulative gap

1 day $50 000 $120 000 –$70 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000 –$40 000
3 to 6 months $100 000 $100 000 $0 –$40 000
6 to 12 months $250 000 $80 000 $170 000 $130 000
1 to 5 years $75 000 $130 000 –$55 000 $75 000
Over 5 years $25 000 $100 000 –$75 000 $0
repriced over five years is an increase of 50 basis points?
A. $7500
B. $7500
C. $0
D. Not enough information to answer the question.

A. The repricing gap model is a market value accounting cash flow analysis of the repricing gap between the interest
revenue earned on assets and the interest paid on liabilities over some period.
B. The repricing gap model is a book value accounting cash flow analysis of the repricing gap between the interest
C. The repricing gap model is a market value accounting cash flow analysis of the repricing gap between the interest
revenue earned on liabilities and the interest paid on assets over some period.
D. The repricing gap model is a book value accounting cash flow analysis of the repricing gap between the interest
A. As opposed to the duration model, the repricing gap model is a market-value based approach.
B. As opposed to the maturity model, the repricing gap model is a market-value based approach.
C. The capital loss effect is captured by the repricing model.
15. The term core deposits refers to those deposits that:
A. act as long-term sources of funds for the FI.
B. reflect the true or core nature of the FI's operations.
C. support the core of the FI's operations.
16. Which of the following are rate-sensitive assets?
A. Short-term consumer loans, cheque accounts and three-month Treasury notes.
B. Ten-year fixed rate mortgages, short-term consumer loans and long-term consumer loans.
C. Short-term consumer loans, ten-year fixed rate mortgages and one-year term deposits.
D. Short-term consumer loans, six-month Treasury notes and three-year
17. Which of the following are rate-sensitive liabilities?
B. Three-month term deposits, three month bankers' acceptances, six-month negotiable certificates of deposit and one-
year term deposits.
C. Short-term consumer loans, six-month negotiable certificates of deposit and one-year term deposits.
D. Short-term consumer loans, six-month Treasury notes and three-year Treasury bonds.
18. The term 'runoffs' refers to:
A. one-off cash flow of interest and principal amortisation payments on long-term assets.
B. periodic cash flow of interest and principal amortisation payments on long-term assets.
C. one-off cash flow of interest and principal amortisation payments on short-term assets.
D. periodic cash flow of interest and principal amortisation payments on short-term assets.
A. Cheque accounts are a type of interest-sensitive asset.
B. Cheque accounts are a type of interest-sensitive liability.
C. There are strong arguments for and against the inclusion of cheque accounts as a type of interest-sensitive asset.
D. There are strong arguments for and against the inclusion of cheque accounts as a type of interest-sensitive liability.

20. Which of the following statements is false?
A. A major reason for cheque accounts to be included in an FI's interest-sensitive liabilities is that the majority of these
accounts are core deposits.
B. Cheque accounts should be treated as interest-sensitive liabilities because if interest rates rise, deposits might be
withdrawn and thus will need to be replaced by higher-yielding deposits.
C. The final decision whether or not to include cheque accounts as rate sensitive liabilities must be made after an
analysis of the actual deposit history.
A. A major reason for cheque accounts to be excluded from an FI's interest-sensitive liabilities is that the majority of these
B. Cheque accounts should be treated as interest-sensitive liabilities because if interest rates fall, deposits might be
C. The final decision whether or not to include cheque accounts as rate sensitive liabilities must be made by predicting
depositors' behaviours.
A. The cumulative repricing gap can also be expressed as a percentage of liabilities.
B. The cumulative repricing gap can also be expressed as a percentage of equity.
C. The cumulative repricing gap can also be expressed as a percentage of assets.
A. Expressing the repricing gap as a percentage of assets tells us the direction of the interest rate exposure.
B. Expressing the repricing gap as a percentage of liabilities tells us the scale of the interest rate exposure.
C. Expressing the repricing gap as a percentage of equity tells us the scale of the interest rate exposure.
D. Expressing the repricing gap as a percentage of liabilities tells us the direction of the interest rate exposure.
A. An FI with a positive repricing gap expects interest rates to remain stable.
B. An FI with a positive repricing gap expects interest rates to rise.
C. An FI with a positive repricing gap expects interest rates to remain fall.
D. An FI with a positive repricing gap has not particular expectations regarding interest rate movements.
A. An FI with a negative repricing gap expects interest rates to remain stable.
B. An FI with a negative repricing gap expects interest rates to rise.
C. An FI with a negative repricing gap expects interest rates to remain fall.
D. An FI with a negative repricing gap has not particular expectations regarding interest rate movements.
A. An FI with a repricing gap of zero is unsure about interest rate movements.
B. An FI with a repricing gap of zero expects interest rates to rise.
C. An FI with a repricing gap of zero expects interest rates to remain fall.
D. An FI with a repricing gap of zero does not measure and manage its interest rate exposures.

27. Assume you are the manager of an FI. How would you structure your balance sheet using the repricing gap model if
you expected interest rates to increase?
A. I would create a positive gap.
B. I would create a negative gap.
C. I would create a neutral gap.
D. It would depend on my FI's current profitability.
A. As opposed to the duration gap model, the repricing gap model captures the capital loss and capital gain effect.
B. The repricing gap model is a market-value based approach, while the duration model is a book-value based approach.
C. The repricing gap model does not consider the size and timing of cash flows.
D. The duration gap model focuses on the impact interest rate changes have on an FI's net interest income.
A. An FI that has a positive on-balance-sheet gap and a negative off-balance-sheet gap is not sure about interest
movements.
B. An FI that has a positive on-balance-sheet gap and a negative off-balance-sheet gap has made a mistake in hedging
its interest rate risk.
C. An FI that has a positive on-balance-sheet gap and a negative off-balance-sheet gap is using its off-balance-sheet
position to hedge its on-balance-sheet position.
A. One problem with the repricing gap is over-aggregation, which means that while the dollar value of asset-sensitive
liabilities and assets within one bucket might be the same, the repricing timing for assets and liabilities within this bucket
might differ.
B. One problem with the repricing gap is over-aggregation, which means that managers cannot make informed decisions
about interest rate movements.
C. An advantage of the repricing gap is over-aggregation, which means that the information provided in the buckets is
precise.
A. The size of the range over which bucket gaps are calculated does not matter as the repricing gap will always lead to
exact results.
B. The shorter the range over which bucket gaps are calculated, the greater the potential error.
C. The shorter the range over which bucket gaps are calculated, the smaller the potential error.
A. The runoff component is rate-sensitive.
B. The runoff component is rate-insensitive.
C. The runoff component refers to interest payments on long-term liabilities that need to be refinanced at market rates.
D. The run-off component refers to interest payments on short-term liabilities that need to be refinanced at market rates.

33. Consider the following table:

Assets Liabilities
Item $ amount runoff $ amount runoff Item $ amount runoff $ amount runoff
in less tgan one in more tgan one in less tgan one in more tgan one
year year year year
Short-term consumer loans $45 $50 Equity $0 $5
Long-term consumer loans $50 $60 Demand deposits $25 $30
Three-month $5 $0 Savings accounts $20 $15

T-notes
Six-month $25 $0 Three-month CDs $5 $0

T-notes
Three-year notes $15 $2 Six-month CDs $12 $0
10-year mortgages $5 $20 Six-month commercial $2 $4

papers
30-year floating rate mortgages $30 $0 One-year term deposits $4 $0
Two-year term deposits $20 $0
$175 $132 $88 $54
What is the one-year gap adjusted for runoffs?
A. $43
B. $87
C. $121
D. $78


Assets Liabilities
year year year year

T-notes

T-notes

papers
A. $0
B. $50
C. $55
D. $5.


Assets Liabilities
year year year year

T-notes

T-notes

papers
$175 $132 $88 $54
How does a decrease in the average one-year interest rate of 50 basis points affect the FI's future net interest income?
A. The NII decreases by $0.435.
B. The NII increases by $0.435.
C. The NII remains constant.
D. The NII decreases by $0.39.


Assets Liabilities
year year year year

T-notes

T-notes

papers
How does an increase in the average one-year interest rate of 50 basis points affect the FI's future net interest income ?

A. The NII will not change.
B. The NII will increase by $50.
C. The NII will increase by $5.
D. The NII will decrease by $50.

37. How do you interpret the position of an FI with a negative on-balance-sheet gap and a positive off-balance-sheet
gap?
A. The FI uses its on-balance-sheet activities to hedge its off-balance-sheet activities.
B. The FI uses its off-balance-sheet activities to hedge its on-balance-sheet activities.
C. The FI believes that interest rates will decrease and made a mistake in setting its gap for off-balance-sheet activities.
D. The FI believes that interest rates will decrease and made a mistake in setting its gap for on-balance-sheet activities.

A. The major focus of the repricing gap is the capital loss effect.
B. The major focus of the repricing gap is the capital gains effect.
C. The repricing gap focuses on all three, the capital gains, the capital loss and the interest income effect.
D. The major focus of the repricing gap is the interest income effect.
39. How do you interpret the position of an FI with a positive on-balance-sheet gap and a negative off-balance sheet
gap?
C. The FI believes that interest rates will increase and made a mistake in setting its gap for off-balance-sheet activities.
D. The FI believes that interest rates will increase and made a mistake in setting its gap for on-balance-sheet activities.
40. When repricing all interest sensitive assets and all interest sensitive liabilities in a balance sheet, the cumulative gap
will be:
A. zero.
B. one.
C. greater than one.
D. a negative value.
41. The repricing gap approach calculates the gaps in each maturity bucket by subtracting the:
A. current assets from the current liabilities.
B. long-term liabilities from the fixed assets.
C. rate sensitive assets from the total assets.
D. rate sensitive liabilities from the rate sensitive assets.
42. The bank has a positive repricing gap. Is it exposed to interest rate increases or decreases and why?
A. Interest rate increases because the interest income on its assets will rise more than the interest expenses on its
liabilities and net interest income will rise.
B. Interest rate increases because the interest income on its assets will fall more than the interest expenses on its
liabilities and net interest income will fall.
C. Interest rate decreases because the interest income on its assets will rise more than the interest expenses on its
D. Interest rate decreases because the interest income on its assets will fall more than the interest expenses on its
43. The bank has a negative repricing gap. Is it exposed to interest rate increases or decreases and why?
B. Interest rate increases because the interest income on its assets will rise by less than the interest expenses on its
D. Interest rate decreases because the interest income on its assets will rise by less than the interest expenses on its

44. The Reserve Bank of Australia's (RBA) monetary policy can reduce an FI's interest rate risk:
A. by smoothing or targeting the level of interest rates it increases unexpected interest rate shocks and interest volatility.
B. by smoothing or targeting the level of interest rates it decreases unexpected interest rate shocks and interest volatility.
C. by letting interest rates find their own level it increases interest volatility.
D. All of the listed options are correct.
45. The Reserve Bank of Australia's (RBA) undertook actions in regards to their open market operation in the post global
financial crisis environment to move financial markets towards greater stability. This was achieved by:
A. increasing the maturity of repos to reduce money pressure in the money market over the longer term.
B. increasing RBA holdings of non-government securities for use with repos due to the shortage of government securities
C. increasing the supply of deposits held by banks and other authorised deposit-taking institutions in their exchange
settlement accounts held with the RBA.
46. The repricing model ignores information regarding the distribution of assets and liabilities within maturity buckets. This
limitation of the model refers to:
A. market value effect.
B. over-aggregation.
C. runoffs and pre-payments.
D. off-balance sheet activities.
47. If an FI's repricing gap is less than zero, then:
A. it is deficient in its required reserves.
B. it is deficient in its capital ratio requirement.
C. its liability costs are more sensitive to changing market interest rates than are its asset yields.
D. its liability costs are less sensitive to changing market interest rates than are its asset yields.
48. Consider the following information to answer the question:

Assets Amount Rate Liabilities Amount Rate
Rate $35 000 000 10% Rate $40 000 000 8%
Sensitive Sensitive
Fixed rate $21 000 000 9% Fixed rate $12 000 000 7%
Non-earning $4 000 000 Equity $8 000 000
What will be the FI's net interest income at year-end if interest rates do not change?

A. $3.20 million
B. $5.39 million
C. $1.89 million
D. $1.35 million


Rate $35 000 000 10% Rate $40 000 000 8%
Sensitive Sensitive
What is the repricing gap for the FI?

A. $0
B. $5 000 000
C. $9 800 000
D. –$5 000 000

50. Which of the following is a weakness of the repricing model to measure interest rate risk?
A. Potential for over-aggregation of assets and liabilities within each maturity bucket.
B. It ignores how changes in interest rates affect the market value of assets and liabilities.
C. It ignores the reinvestment of loan interest and principal payments that are reinvested at current market rates and it
fails to recognise off-balance-sheet activities that may be rate sensitive.
51. The unbiased expectations theory of the term structure of interest rates:
A. assumes that long-term interest rates are an arithmetic average of short-term rates.
B. assumes that the yield curve reflects the market's current expectations of future short-term interest rates.
C. recognises that forward rates are perfect predictors of future interest rates.
D. assumes that risk premiums increase uniformly with maturity.
52. The liquidity premium theory of the term structure of interest rates:
A. assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the
uncertainty of the long term.
B. assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium.

53. The market segmentation theory of the term structure of interest rates:
C. assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity
buckets.
D. assumes that both investors and borrowers are willing to shift from one maturity sector to another to take advantage of
opportunities arising from changing yields.
54. The repricing gap considers the timing and size of cash flows.
True False
55. The repricing gap focuses on the interest income effect.
True False
56. An FI with a positive repricing gap expects interest rates to decrease.
True False
57. An FI with a neutral repricing gap in its three to six month bucket is hedged against any interest rate changes at all
points in time.
True False
58. The repricing gap is a book-value based approach.
True False
59. Over-aggregation and runoffs are the major problems associated with the repricing gap.
True False
60. Convexity is the major problem associated with the repricing gap.
True False
61. The cumulative repricing gap position of an FI for a given extended time period is the sum of the repricing gap values
for the individual time periods that make up the extended time period.
True False
62. An FI with a negative gap of $20 million suffers a $0.2 million decrease in its net interest income if interest rates
decrease by 1 per cent.
True False

63. An FI with a positive gap of $30 million suffers a $0.15 million decrease in its net interest income if interest rates
increase by 0.5 per cent.
True False
64. Because the repricing model ignores the market value effect of changing interest rates, the repricing gap is an
incomplete measure of the true interest rate risk exposure of an FI.
True False
65. If the spread between rate sensitive assets and rate sensitive liabilities increases for a bank, future changes in
interest rates will lead to an increase in net interest income.
True False
66. In the last quarter ABC Bank reported the following repricing buckets:
Repricing buckets Assets Liabilities

1 day $50 $100
1 day to 3 months $120 $25
3 months to 6 months $35 $100
1 year to 5 years $70 $40
Over 5 years $60 $60
Calculate the repricing gaps for each maturity bucket and the cumulative gaps.

67. What is meant by the 'run-off' problem and how can bank managers deal with this problem?

68. Would you consider the repricing model to be a good and well-founded interest rate risk measurement and
management tool? Why or why not?

69. Outline what is meant by the CGAP effect and explain the relationship between interest rate changes and changes in
net interest income. Specifically indicate whether a FI would wish to hold a negative or positive CGAP and under which
interest rate conditions.

Chapter 05 - Testbank Key

1. Repricing gap refers to the:
A. difference between rate-sensitive assets and rate-sensitive liabilities.
B. sum of rate-sensitive assets and rate-sensitive liabilities.
C. difference between rate-sensitive liabilities and rate-sensitive assets.
D. difference between rate-insensitive assets and rate-insensitive liabilities.
Difficulty: Easy
Learning Objective: 05-03 Learn tgat at tge geart of interest rate risk is tge tendency of many modern FIs to mismatcg tge maturities of tgeir assets and
liabilities (for example, banks normally use sgort-term deposits to fund long term-loans) and tgat tgis mismatcging can give rise to significant interest rate
exposure and insolvency risk.
2. The term 'rate-sensitive assets' refers to assets:
A. whose interest rate will be repriced over some future period.
B. with a particularly high interest rate.
C. with a particularly low interest rate.
D. for which demand is highly dependent on the level of interest rates.
Difficulty: Easy
A. APRA requires smaller Australian FIs to use the repricing gap method to estimate interest rate exposures in their
B. Australian FIs are only required to use the repricing gap method if they are listed on an US stock exchange.
C. APRA does not require Australian FIs to use the repricing gap method to estimate interest rate exposures in their
D. Australian FIs are only required to use the repricing gap if they are internationally active.
Difficulty: Medium
4. What is spread effect?
A. Periodic cash flow of interest and principal amortisation payments on long-term assets that can be reinvested at
market rates.
B. The effect that a change in the spread between rates on rate sensitive assets and rate sensitive liabilities has on net
interest income as interest rates change.
C. The effect of mismatch of asset and liabilities within a maturity bucket.
D. The premium paid to compensate for the future uncertainty in a security's value.
Difficulty: Medium
5. The cumulative gap over the whole balance sheet by definition:
A. must be greater than zero.
B. must be lower than zero.
C. must equal zero.
D. can take any value.
Difficulty: Easy
A. A negative gap indicates that a rise in interest rates would lower the bank's net interest income.
B. A positive gap indicates that a rise in interest rates would lower the bank's net interest income.
C. A negative gap indicates that a rise in interest rates would increase the bank's net interest income.
Difficulty: Medium
A. A negative gap indicates that a rise in interest rates would increase the bank's net interest income.
B. A positive gap indicates that a rise in interest rates would increase the bank's net interest income.
C. A positive gap indicates that a fall in interest rates would increase the bank's net interest income.
Difficulty: Medium


1 day $000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
What is the annualised change in the bank's future net interest income if the overnight interest rate decreased by 100 basis points?
A. –$700
B. $700
C. –$7000
D. $700

Difficulty: Medium


1 day $50 000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
What is the annualised change in the bank's future net interest income if the overnight interest rate increased by 100 basis points?
A. –$700
B. $700
C. –$7000
D. $700

Difficulty: Medium


1 day $50 000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
repriced within one year is an increase of 100 basis points?
A. $17 000
B. –$17 000
C. $13 000
D. –$13 000

Difficulty: Hard


1 day $50 000 $120 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000
3 to 6 months $100 000 $100 000 $0
6 to 12 months $250 000 $80 000 $170 000
1 to 5 years $75 000 $130 000 –$55 000
Over 5 years $25 000 $100 000 –$75 000
repriced within one year is a decrease of 100 basis points?
A. $17 000
B. –$17 000
C. $13 000
D. –$13 000

Difficulty: Hard

Repricing bucket Assets Liabilities Gaps Cumulative gap

1 day $50 000 $120 000 –$70 000 –$70 000
1 day to 3 months $100 000 $70 000 $30 000 –$40 000
3 to 6 months $100 000 $100 000 $0 –$40 000
6 to 12 months $250 000 $80 000 $170 000 $130 000
1 to 5 years $75 000 $130 000 –$55 000 $75 000
Over 5 years $25 000 $100 000 –$75 000 $0
repriced over five years is an increase of 50 basis points?
A. $7500
B. $7500
C. $0
D. Not enough information to answer the question.

Difficulty: Medium
A. The repricing gap model is a market value accounting cash flow analysis of the repricing gap between the interest
B. The repricing gap model is a book value accounting cash flow analysis of the repricing gap between the interest
C. The repricing gap model is a market value accounting cash flow analysis of the repricing gap between the interest
D. The repricing gap model is a book value accounting cash flow analysis of the repricing gap between the interest
Difficulty: Medium
A. As opposed to the duration model, the repricing gap model is a market-value based approach.
B. As opposed to the maturity model, the repricing gap model is a market-value based approach.
C. The capital loss effect is captured by the repricing model.
Difficulty: Medium
15. The term core deposits refers to those deposits that:
A. act as long-term sources of funds for the FI.
B. reflect the true or core nature of the FI's operations.
C. support the core of the FI's operations.
Difficulty: Easy
Learning Objective: 05-04 Gain an understanding of rate sensitive assets and rate sensitive liabilities.
16. Which of the following are rate-sensitive assets?
B. Ten-year fixed rate mortgages, short-term consumer loans and long-term consumer loans.
C. Short-term consumer loans, ten-year fixed rate mortgages and one-year term deposits.
D. Short-term consumer loans, six-month Treasury notes and three-year
Difficulty: Medium
17. Which of the following are rate-sensitive liabilities?
B. Three-month term deposits, three month bankers' acceptances, six-month negotiable certificates of deposit and one-
year term deposits.
C. Short-term consumer loans, six-month negotiable certificates of deposit and one-year term deposits.
D. Short-term consumer loans, six-month Treasury notes and three-year Treasury bonds.
Difficulty: Medium
18. The term 'runoffs' refers to:
A. one-off cash flow of interest and principal amortisation payments on long-term assets.
B. periodic cash flow of interest and principal amortisation payments on long-term assets.
C. one-off cash flow of interest and principal amortisation payments on short-term assets.
D. periodic cash flow of interest and principal amortisation payments on short-term assets.
Difficulty: Medium
Learning Objective: 05-05 Learn tge weaknesses of tge repricing model.
A. Cheque accounts are a type of interest-sensitive asset.
B. Cheque accounts are a type of interest-sensitive liability.
C. There are strong arguments for and against the inclusion of cheque accounts as a type of interest-sensitive asset.
D. There are strong arguments for and against the inclusion of cheque accounts as a type of interest-sensitive liability.
Difficulty: Medium
20. Which of the following statements is false?
A. A major reason for cheque accounts to be included in an FI's interest-sensitive liabilities is that the majority of these
B. Cheque accounts should be treated as interest-sensitive liabilities because if interest rates rise, deposits might be
C. The final decision whether or not to include cheque accounts as rate sensitive liabilities must be made after an
analysis of the actual deposit history.
Difficulty: Hard
A. A major reason for cheque accounts to be excluded from an FI's interest-sensitive liabilities is that the majority of these
B. Cheque accounts should be treated as interest-sensitive liabilities because if interest rates fall, deposits might be
C. The final decision whether or not to include cheque accounts as rate sensitive liabilities must be made by predicting
depositors' behaviours.
Difficulty: Hard
A. The cumulative repricing gap can also be expressed as a percentage of liabilities.
B. The cumulative repricing gap can also be expressed as a percentage of equity.
C. The cumulative repricing gap can also be expressed as a percentage of assets.
Difficulty: Medium
A. Expressing the repricing gap as a percentage of assets tells us the direction of the interest rate exposure.
B. Expressing the repricing gap as a percentage of liabilities tells us the scale of the interest rate exposure.
C. Expressing the repricing gap as a percentage of equity tells us the scale of the interest rate exposure.
D. Expressing the repricing gap as a percentage of liabilities tells us the direction of the interest rate exposure.
Difficulty: Medium
A. An FI with a positive repricing gap expects interest rates to remain stable.
B. An FI with a positive repricing gap expects interest rates to rise.
C. An FI with a positive repricing gap expects interest rates to remain fall.
D. An FI with a positive repricing gap has not particular expectations regarding interest rate movements.
Difficulty: Easy
A. An FI with a negative repricing gap expects interest rates to remain stable.
B. An FI with a negative repricing gap expects interest rates to rise.
C. An FI with a negative repricing gap expects interest rates to remain fall.
D. An FI with a negative repricing gap has not particular expectations regarding interest rate movements.
Difficulty: Easy
A. An FI with a repricing gap of zero is unsure about interest rate movements.
B. An FI with a repricing gap of zero expects interest rates to rise.
C. An FI with a repricing gap of zero expects interest rates to remain fall.
D. An FI with a repricing gap of zero does not measure and manage its interest rate exposures.
Difficulty: Easy
27. Assume you are the manager of an FI. How would you structure your balance sheet using the repricing gap model if
you expected interest rates to increase?
A. I would create a positive gap.
B. I would create a negative gap.
C. I would create a neutral gap.
D. It would depend on my FI's current profitability.
Difficulty: Easy
A. As opposed to the duration gap model, the repricing gap model captures the capital loss and capital gain effect.
B. The repricing gap model is a market-value based approach, while the duration model is a book-value based approach.
C. The repricing gap model does not consider the size and timing of cash flows.
D. The duration gap model focuses on the impact interest rate changes have on an FI's net interest income.
Difficulty: Medium
A. An FI that has a positive on-balance-sheet gap and a negative off-balance-sheet gap is not sure about interest
movements.
B. An FI that has a positive on-balance-sheet gap and a negative off-balance-sheet gap has made a mistake in hedging
its interest rate risk.
C. An FI that has a positive on-balance-sheet gap and a negative off-balance-sheet gap is using its off-balance-sheet
position to hedge its on-balance-sheet position.
Difficulty: Hard
A. One problem with the repricing gap is over-aggregation, which means that while the dollar value of asset-sensitive
liabilities and assets within one bucket might be the same, the repricing timing for assets and liabilities within this bucket
might differ.
B. One problem with the repricing gap is over-aggregation, which means that managers cannot make informed decisions
about interest rate movements.
C. An advantage of the repricing gap is over-aggregation, which means that the information provided in the buckets is
precise.
Difficulty: Medium
A. The size of the range over which bucket gaps are calculated does not matter as the repricing gap will always lead to
exact results.
B. The shorter the range over which bucket gaps are calculated, the greater the potential error.
C. The shorter the range over which bucket gaps are calculated, the smaller the potential error.
Difficulty: Medium
A. The runoff component is rate-sensitive.
B. The runoff component is rate-insensitive.
C. The runoff component refers to interest payments on long-term liabilities that need to be refinanced at market rates.
D. The run-off component refers to interest payments on short-term liabilities that need to be refinanced at market rates.
Difficulty: Medium

Assets Liabilities
year year year year

T-notes

T-notes

papers
$175 $132 $88 $54

A. $43
B. $87
C. $121
D. $78

Difficulty: Medium

Assets Liabilities
year year year year

T-notes

T-notes

papers
A. $0
B. $50
C. $55
D. $5.

Difficulty: Hard

Assets Liabilities
year year year year

T-notes

T-notes

papers
$175 $132 $88 $54
How does a decrease in the average one-year interest rate of 50 basis points affect the FI's future net interest income?
A. The NII decreases by $0.435.
B. The NII increases by $0.435.
C. The NII remains constant.
D. The NII decreases by $0.39.

Difficulty: Hard

Assets Liabilities
year year year year

T-notes

T-notes

papers
How does an increase in the average one-year interest rate of 50 basis points affect the FI's future net interest income ?

A. The NII will not change.
B. The NII will increase by $50.
C. The NII will increase by $5.
D. The NII will decrease by $50.

Difficulty: Hard
37. How do you interpret the position of an FI with a negative on-balance-sheet gap and a positive off-balance-sheet
gap?
C. The FI believes that interest rates will decrease and made a mistake in setting its gap for off-balance-sheet activities.
D. The FI believes that interest rates will decrease and made a mistake in setting its gap for on-balance-sheet activities.
Difficulty: Medium
A. The major focus of the repricing gap is the capital loss effect.
B. The major focus of the repricing gap is the capital gains effect.
C. The repricing gap focuses on all three, the capital gains, the capital loss and the interest income effect.
D. The major focus of the repricing gap is the interest income effect.
Difficulty: Easy
39. How do you interpret the position of an FI with a positive on-balance-sheet gap and a negative off-balance sheet
gap?
C. The FI believes that interest rates will increase and made a mistake in setting its gap for off-balance-sheet activities.
D. The FI believes that interest rates will increase and made a mistake in setting its gap for on-balance-sheet activities.
Difficulty: Hard
40. When repricing all interest sensitive assets and all interest sensitive liabilities in a balance sheet, the cumulative gap
will be:
A. zero.
B. one.
C. greater than one.
D. a negative value.
Difficulty: Medium
41. The repricing gap approach calculates the gaps in each maturity bucket by subtracting the:
A. current assets from the current liabilities.
B. long-term liabilities from the fixed assets.
C. rate sensitive assets from the total assets.
D. rate sensitive liabilities from the rate sensitive assets.
Difficulty: Easy
42. The bank has a positive repricing gap. Is it exposed to interest rate increases or decreases and why?
B. Interest rate increases because the interest income on its assets will fall more than the interest expenses on its
D. Interest rate decreases because the interest income on its assets will fall more than the interest expenses on its
Difficulty: Hard
43. The bank has a negative repricing gap. Is it exposed to interest rate increases or decreases and why?
B. Interest rate increases because the interest income on its assets will rise by less than the interest expenses on its
D. Interest rate decreases because the interest income on its assets will rise by less than the interest expenses on its
Difficulty: Hard
44. The Reserve Bank of Australia's (RBA) monetary policy can reduce an FI's interest rate risk:
A. by smoothing or targeting the level of interest rates it increases unexpected interest rate shocks and interest volatility.
B. by smoothing or targeting the level of interest rates it decreases unexpected interest rate shocks and interest volatility.
C. by letting interest rates find their own level it increases interest volatility.
Difficulty: Medium
Learning Objective: 05-01 Appreciate tge influence tgat tge RBA gas on interest rates and wgy tgis is tge case.
45. The Reserve Bank of Australia's (RBA) undertook actions in regards to their open market operation in the post global
financial crisis environment to move financial markets towards greater stability. This was achieved by:
A. increasing the maturity of repos to reduce money pressure in the money market over the longer term.
B. increasing RBA holdings of non-government securities for use with repos due to the shortage of government securities
C. increasing the supply of deposits held by banks and other authorised deposit-taking institutions in their exchange
settlement accounts held with the RBA.
Difficulty: Medium
Learning Objective: 05-01 Appreciate tge influence tgat tge RBA gas on interest rates and wgy tgis is tge case.
46. The repricing model ignores information regarding the distribution of assets and liabilities within maturity buckets. This
limitation of the model refers to:
A. market value effect.
B. over-aggregation.
C. runoffs and pre-payments.
D. off-balance sheet activities.
Difficulty: Medium
47. If an FI's repricing gap is less than zero, then:
A. it is deficient in its required reserves.
B. it is deficient in its capital ratio requirement.
C. its liability costs are more sensitive to changing market interest rates than are its asset yields.
D. its liability costs are less sensitive to changing market interest rates than are its asset yields.
Difficulty: Medium

Rate $35 000 000 10% Rate $40 000 000 8%
Sensitive Sensitive
What will be the FI's net interest income at year-end if interest rates do not change?

A. $3.20 million
B. $5.39 million
C. $1.89 million
D. $1.35 million

Difficulty: Hard

Rate $35 000 000 10% Rate $40 000 000 8%
Sensitive Sensitive
What is the repricing gap for the FI?

A. $0
B. $5 000 000
C. $9 800 000
D. –$5 000 000

Difficulty: Hard
50. Which of the following is a weakness of the repricing model to measure interest rate risk?
A. Potential for over-aggregation of assets and liabilities within each maturity bucket.
B. It ignores how changes in interest rates affect the market value of assets and liabilities.
C. It ignores the reinvestment of loan interest and principal payments that are reinvested at current market rates and it
fails to recognise off-balance-sheet activities that may be rate sensitive.
Difficulty: Medium
51. The unbiased expectations theory of the term structure of interest rates:
A. assumes that long-term interest rates are an arithmetic average of short-term rates.
Difficulty: Medium
Learning Objective: 05-07 Gain an understanding of tge tgeory begind term structure of interest rates.
52. The liquidity premium theory of the term structure of interest rates:
B. assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium.
Difficulty: Medium
53. The market segmentation theory of the term structure of interest rates:
C. assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity
buckets.
D. assumes that both investors and borrowers are willing to shift from one maturity sector to another to take advantage of
opportunities arising from changing yields.
Difficulty: Medium
54. The repricing gap considers the timing and size of cash flows.
FALSE
Difficulty: Easy
55. The repricing gap focuses on the interest income effect.
TRUE
Difficulty: Easy
56. An FI with a positive repricing gap expects interest rates to decrease.
FALSE
Difficulty: Medium
57. An FI with a neutral repricing gap in its three to six month bucket is hedged against any interest rate changes at all
points in time.
FALSE
Difficulty: Hard
58. The repricing gap is a book-value based approach.
TRUE
Difficulty: Easy
59. Over-aggregation and runoffs are the major problems associated with the repricing gap.
TRUE
Difficulty: Medium
60. Convexity is the major problem associated with the repricing gap.
FALSE
Difficulty: Medium
61. The cumulative repricing gap position of an FI for a given extended time period is the sum of the repricing gap values
for the individual time periods that make up the extended time period.
TRUE
Difficulty: Medium
62. An FI with a negative gap of $20 million suffers a $0.2 million decrease in its net interest income if interest rates
decrease by 1 per cent.
FALSE
Difficulty: Medium
63. An FI with a positive gap of $30 million suffers a $0.15 million decrease in its net interest income if interest rates
increase by 0.5 per cent.
FALSE
Difficulty: Medium
64. Because the repricing model ignores the market value effect of changing interest rates, the repricing gap is an
incomplete measure of the true interest rate risk exposure of an FI.
TRUE
Difficulty: Medium
65. If the spread between rate sensitive assets and rate sensitive liabilities increases for a bank, future changes in
interest rates will lead to an increase in net interest income.
TRUE
Difficulty: Medium
66. In the last quarter ABC Bank reported the following repricing buckets:
Repricing buckets Assets Liabilities

1 day $50 $100
1 day to 3 months $120 $25
1 year to 5 years $70 $40
Over 5 years $60 $60
Calculate the repricing gaps for each maturity bucket and the cumulative gaps.
Repricing buckets Assets Liabilities Gaps Cumulative gap

1 day $50 $100 –$50 –$50
1 day to 3 months $120 $25 + $95 +$45
3 months to 6 months $35 $100 –$65 –$20
6 months to 12 months $65 $75 –$10 –$30
1 year to 5 years $70 $40 +$30 0
Over 5 years $60 $60 0 0

Est time: 5-10 minutes

67. What is meant by the 'run-off' problem and how can bank managers deal with this problem?
In the simple repricing model, we assume that loans of one type mature at the same time; for example, all one-year
consumer loans mature in one year's time and all 10-year fixed-rate mortgages mature in 10 years' time.
In reality, the bank continuously originates and retires consumer mortgages and all types of loans as it creates and retires
deposits. For example, today some 10-year fixed-rate mortgages may only have one year left before they are repriced;
that is, they are in their 9th year. In addition, virtually all housing mortgages pay at least some principal back to the bank
each month.
As a result, the bank receives a runoff cash flow from its conventional mortgage portfolio that can be reinvested at current
market rates, making this runoff component rate sensitive. The bank manager can easily deal with this in the repricing
model by identifying for each asset and liability item the estimated dollar cash flow that will runoff, reprice or mature within
the next year and adding these amounts to the rate-sensitive assets and liabilities.

68. Would you consider the repricing model to be a good and well-founded interest rate risk measurement and
management tool? Why or why not?
The repricing gap is a measure of interest rate risk which uses book or historical values of assets and liabilities. It is
conceptually easy to understand and can be used to forecast changes in profitability for given changes in interest rates. In
this way it can assist FI managers to decide the structure of their balance sheet in light of projected interest rate changes.
However, because of the book value approach, the repricing model concentrates on the net interest income effects of rate
changes and ignores the market value effects. In addition, the model ignores important cash flow issues associated with
over-aggregation, runoffs and off-balance-sheet activities. As such, the model does not provide an accurate picture of an
FI's interest rate risk exposure. More complete measures of interest rate risk are provided by duration and the duration
gap model

69. Outline what is meant by the CGAP effect and explain the relationship between interest rate changes and changes in
net interest income. Specifically indicate whether a FI would wish to hold a negative or positive CGAP and under which
interest rate conditions.
The CGAP effect describes the relations between changes in interest rates and changes in net interest income. According
to the CGAP effect, when CGAP is positive the change in NII is positively related to the change in interest rates. Thus, an
FI would want its CGAP to be positive when interest rates are expected to rise. According to the CGAP effect, when
CGAP is negative the change in NII is negatively related to the change in interest rates. Thus, an FI would want its CGAP
to be negative when interest rates are expected to fall.

Chapter 05 - Testbank Summary
Category # of
Que
stion
s
Difficulty: Easy 13
Difficulty: Hard 14
Difficulty: Medium 38
Est time: 10-15 minutes 1
Est time: 5-10 minutes 3
Learning Objective: 05-01 Appreciate the influence that the RBA has on interest rates and why this is the case. 2
Learning Objective: 05-03 Learn that at the heart of interest rate risk is the tendency of many modern FIs to mismatch the mat 34
urities of their assets and liabilities (for example, banks normally use short-term deposits to fund long term-loans) and that this
mismatching can give rise to significant interest rate exposure and insolvency risk.
Learning Objective: 05-04 Gain an understanding of rate sensitive assets and rate sensitive liabilities. 13
Learning Objective: 05-05 Learn the weaknesses of the repricing model. 18
Learning Objective: 05-07 Gain an understanding of the theory behind term structure of interest rates. 3

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Chapter 05 - Testbank

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps Cumulative gap

Short-term consumer loans $45 $50 Equity $0 $5

Long-term consumer loans $50 $60 Demand deposits $25 $30

Three-month $5 $0 Savings accounts $20 $15

Six-month $25 $0 Three-month CDs $5 $0

Three-year notes $15 $2 Six-month CDs $12 $0

10-year mortgages $5 $20 Six-month commercial $2 $4

30-year floating rate mortgages $30 $0 One-year term deposits $4 $0

$175 $132 $88 $54

Long-term consumer loans $5 $6 Demand deposits $20 $10

Three-month $5 $2 Savings accounts $10 $5

Six-month $15 $0 Three-month CDs $5 $2

Three-year notes $5 $2 Six-month CDs $10 $0

10-year mortgages $25 $10 Six-month commercial $5 $4

30-year floating rate mortgages $20 $5 One-year term deposits $17 $4

Short-term consumer loans $45 $50 Equity $0 $5

Long-term consumer loans $50 $60 Demand deposits $25 $30

Three-month $5 $0 Savings accounts $20 $15

Six-month $25 $0 Three-month CDs $5 $0

Three-year notes $15 $2 Six-month CDs $12 $0

10-year mortgages $5 $20 Six-month commercial $2 $4

30-year floating rate mortgages $30 $0 One-year term deposits $4 $0

$175 $132 $88 $54

Long-term consumer loans $5 $6 Demand deposits $20 $10

Three-month $5 $2 Savings accounts $10 $5

Six-month $15 $0 Three-month CDs $5 $2

Three-year notes $5 $2 Six-month CDs $10 $0

10-year mortgages $25 $10 Six-month commercial $5 $4

30-year floating rate mortgages $20 $5 One-year term deposits $17 $4

Assets Amount Rate Liabilities Amount Rate

Rate $35 000 000 10% Rate $40 000 000 8%

Fixed rate $21 000 000 9% Fixed rate $12 000 000 7%

Non-earning $4 000 000 Equity $8 000 000

Assets Amount Rate Liabilities Amount Rate

Rate $35 000 000 10% Rate $40 000 000 8%

Fixed rate $21 000 000 9% Fixed rate $12 000 000 7%

Non-earning $4 000 000 Equity $8 000 000

Repricing buckets Assets Liabilities

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps

Repricing bucket Assets Liabilities Gaps Cumulative gap

Short-term consumer loans $45 $50 Equity $0 $5

Long-term consumer loans $50 $60 Demand deposits $25 $30

Three-month $5 $0 Savings accounts $20 $15

Six-month $25 $0 Three-month CDs $5 $0

Three-year notes $15 $2 Six-month CDs $12 $0

10-year mortgages $5 $20 Six-month commercial $2 $4

30-year floating rate mortgages $30 $0 One-year term deposits $4 $0

$175 $132 $88 $54

Long-term consumer loans $5 $6 Demand deposits $20 $10

Three-month $5 $2 Savings accounts $10 $5

Six-month $15 $0 Three-month CDs $5 $2

Three-year notes $5 $2 Six-month CDs $10 $0

10-year mortgages $25 $10 Six-month commercial $5 $4

30-year floating rate mortgages $20 $5 One-year term deposits $17 $4