When the assets and liabilities of an FI are not equal in size, efficient hedging of interest rate risk can be achieved by

Question

Quizplus · Accepted Answer

Efficient hedging of interest rate risk can be achieved by not exactly matching the maturities of assets and liabilities. This strategy is called gapping, where the FI strategically leaves a gap between the maturities of its assets and liabilities to take advantage of interest rate movements. By having assets with longer maturities than liabilities, the FI can benefit from rising interest rates by earning a higher rate on assets than on liabilities. Conversely, when interest rates decline, the FI may earn less on assets than on liabilities, but the overall impact on net interest income will be less severe than if everything was perfectly matched. This approach allows the FI to manage interest rate risk while still generating income.

When the Assets and Liabilities of an FI Are Not