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FRM Part II · FRM Exam Part II · Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques

A treasurer relies on a repricing gap report with buckets of 0-3 months, 3-6 months, and 6-12 months. Which is the most important limitation of this report as a measure of interest rate risk?

The main limitation is that gap reports lump items into buckets and assume they reprice together and by the same rate change. They ignore intra-bucket timing, basis risk between different rate indices, and embedded options, so the NII sensitivity they imply can be inaccurate.

  1. AIt ignores differences in timing of repricing within each bucket and basis risk between rates, so assets and liabilities in the same bucket are treated as repricing togetherCorrect
  2. BIt cannot be computed for floating-rate instruments
  3. CIt measures only the market value of equity, not earnings
  4. DIt requires a forecast of credit spreads for every borrower

Explanation

Gap reports group items into buckets and assume they reprice at the same time and by the same amount, ignoring intra-bucket timing, basis risk between different rate indices, and options such as prepayments. It is an earnings-based tool and handles floating-rate items easily by their reset date. It does not need credit spread forecasts.

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