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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

A bank's treasury borrows short-term wholesale funds and uses them to fund long-dated fixed-rate loans. Which risk is most directly created by this maturity mismatch if short-term market rates rise sharply?

The mismatch creates interest rate and funding cost risk. Liabilities reprice quickly while fixed-rate loans do not, so rising short rates raise funding costs without raising income, squeezing the bank's net interest margin.

  1. AReinvestment and funding cost risk that squeezes net interest marginCorrect
  2. BSettlement risk from delayed payment finality
  3. CModel risk from using an incorrect pricing formula
  4. DLegal risk from unenforceable loan contracts

Explanation

Funding short and lending long fixed means liabilities reprice faster than assets. When short rates rise, funding costs increase while loan income is fixed, compressing net interest margin. The other risks are not the direct result of the maturity mismatch.

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