CAIIB Paper 2 Module D Quiz 6

EVE is an economic-value measure based on the present value of expected asset cash flows less liability cash flows, with relevant off-balance-sheet positions included according to the methodology.

NII sensitivity helps assess how asset and liability repricing changes earnings over a defined horizon. It complements EVE analysis because short-term earnings and longer-term economic value can respond differently.

For gap analysis, rate-sensitive positions are commonly allocated according to the next repricing date, not simply original maturity. Behavioural and regulatory conventions may affect the precise treatment.

Faster prepayments shorten asset cash flows and can force reinvestment at lower yields. If prepayment assumptions are wrong, measured duration, EVE and earnings sensitivity may be inaccurate.

Deposit beta is the pass-through of market-rate changes to deposit rates. A low or delayed beta can protect margins in some rising-rate scenarios, but behaviour varies by product and competitive conditions.

Deposit decay models estimate how non-maturity balances decline or remain over time. Assumptions should be based on evidence, segment differences and stress behaviour, and must be validated.

Behavioural assumptions for prepayments, non-maturity deposits and rate pass-through can materially change results. Independent validation and back-testing help identify bias, weakness and model drift.

Back-testing compares prior predictions or assumptions with realised behaviour or outcomes. It can reveal whether models systematically under- or over-estimate cash flows or sensitivity.

Limit breaches should trigger documented escalation and timely assessment. Corrective measures may include repositioning, hedging, funding changes or formally approved limit revisions.

An economic hedge can reduce risk while still causing accounting mismatches or earnings volatility. Hedge accounting has specific eligibility, documentation and effectiveness requirements and does not remove underlying risk.

In a pay-fixed, receive-floating swap, floating receipts generally rise as the reference rate resets higher. The net value impact depends on the swap’s terms, curve, remaining maturity and the exposure being hedged.

Receiving fixed while paying floating means higher floating payments reduce the net receipt or increase the net payment, all else equal. This is often used to transform floating-rate exposure toward fixed-rate exposure.

Different currencies have different yield curves, funding markets and basis behaviour. Aggregating them without suitable analysis can hide material exposures; currency-specific measurement is often necessary.

Stress testing explores hypothetical but plausible adverse conditions and their effects on earnings and value. It is not a precise forecast and should complement routine forecasts and sensitivity analysis.

Risk appetite should translate into measurable limits and strategies. A bank sensitive to earnings volatility may use repricing alignment, product pricing, funding changes or hedging while considering costs and residual risks.

IRRBB can affect economic value and earnings, potentially weakening a bank’s capital position. Supervisory frameworks may require assessment, governance and action where exposures are material.

Steepening means the spread between longer and shorter maturities widens. It can result from different combinations of short- and long-term rate movements, so the scenario definition should be explicit.

A flattening curve occurs when long-term yields move closer to short-term yields. The effect on a bank depends on the maturity and repricing structure of assets, liabilities and hedges.

Embedded options alter expected cash flows and sensitivity as rates change. Option-aware approaches can better capture these nonlinear effects than simple static gap or duration methods.

Potential mitigants include changing product mix, repricing assets/liabilities, adjusting funding tenor or using derivatives. Each action has cost, customer, basis, liquidity and counterparty implications that must be evaluated.