Question

On March 1st, 2020, Bloomberg reported that the Federal Reserve is now prepared to reduce interest rates in March to support the economy which is increasingly threatened by the coronavirus (see the news in the pdf format on blackboard).

Suppose a bank has a cumulative GAP of $100 million for the next year and bank management decides to take advantage of the potential rate cut by increasing its interest rate exposure, then it should _____ possibly by _________.

	A.	increase asset sensitivity; making more loans on a floating-rate basis
	B.	reduce asset sensitivity; making more loans on a floating-rate basis
X	C.	increase liability sensitivity; paying premiums to attract short-term deposit instruments.
	D.	reduce liability sensitivity; paying premiums to attract long-term deposit instruments.

Answer 1

In this questions ,

As the company has a cumulative GAP of $100 million for next year

They can get advantage by increasing its interest rate exposure ( it is loss to an individual by change in interest rate on their investment) so they will attract long term deposits ( more than 1 year ).

Also, company can distribute loans in order to earn from it next year too ; in order to decrease its assests senstivity

as Cumalative GAP means Assets senstivity - liabilities senstivity ,Next year it is cut down in interest rates so to increase interest rate exposure ,thus difference can be less by:

1. decrease in assets

2. increase in liability

option 1. is practical as it can be done by floating loans in the market

ANSWER B.) reduce asset sensitivity; making more loans on a floating-rate basis