Question

An asset-sensitive financial institution will typically hedge its position to avoid lower net interest income by:

1. Using an interest rate cap.
2. Executing a long hedge.
3. Using an interest rate collar.
4. Executing a put option

Assume that the US Central Bank increases market interest rates. Your bank’s net interest margin will likely decrease as a result if your bank has:              

1. A negative Interest-sensitive ratio.
2. Relative interest-sensitive gap of zero.
3. A balance sheet that is liability-sensitive.
4. A balance sheet that is asset-sensitive.

Answer 1

Ans : An asset-sensitive financial institution will typically hedge its position to avoid lower net interest income by:

a. Using an interest rate cap: (False) It is provided by Financial Institutions to its mostly to cap Interest rate on Loan provided if current interest rate goes beyond a certain limit. So in a falling interest rate, it is not beneficial for them.

b. Executing a long hedge: (False) A long hedge strategy is an Institution that will go long in the futures market to manage falling interest rates. But if the interest rate falls a long position also makes a loss. So it will bring more pain to the institution.

c. Using an interest rate collar. (False) : Interest rate collar provides a hedge but it locks upper and lower limits on the interest rate. This means if the interest rate goes higher-earning will also be locked. So it is not a preferable scenario as it limits the profitability, so it is not desirable by the institution.

d. Executing a put option. (True) .: A Put option always protects against downside risk given a premium at the time of entry.

Ans :

An asset-sensitive financial institution will typically hedge its position to avoid lower net interest income by: Executing a put option