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FRM Part II · FRM Exam Part II · Monetary and Fiscal Policy: Safeguarding Stability and Trust

A bank risk manager is assessing the transmission of a series of policy rate increases to the bank's balance sheet. Which of the following is the most likely immediate effect of an unexpected rise in the policy rate on a bank that funds long-term fixed-rate loans with short-term deposits that reprice quickly?

Net interest margin narrows because funding costs reprice faster than asset yields. Short-term deposits reset quickly to the higher policy rate, while the long-term fixed-rate loans continue to earn their original coupon, and the higher discount rate also lowers the economic value of those loans.

  1. ANet interest margin widens because loan yields rise immediately
  2. BNet interest margin narrows because funding costs reprice faster than asset yieldsCorrect
  3. CNet interest margin is unchanged because the rate changes offset
  4. DThe economic value of the fixed-rate loans rises

Explanation

Short-term deposits reprice quickly, raising funding costs, while fixed-rate loans keep their old yields, so margin narrows. The value of fixed-rate loans falls, not rises, as discount rates rise. Offsetting would require matched repricing, which is absent here.

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