Question

A bank has just completed an internal stress test and finds that it has a repricing risk of -0.5% to its cash flow for every 1% upward shift in interest rates. What should the bank do to mitigate its risk?

It should securitize and sell its loan portfolio, retaining only the servicing rights.

It should become a counterparty to a currency swap.

It should sell some of its real estate assets.

It should issue more stock to bolster capital reserves.

It should become a counterparty to an interest rate swap.

Answer 1

It should become a counterparty to an interest rate swap

A negative repricing gap implies that the interest sensitive liabilities of the bank are greater than the interest sensitive assets of the bank. This increases the interest rate risk because if the interest rate increases the liabilities are repriced at a higher rate. This will decrease the net income of the bank. In this scenario it will be beneficial for the bank to arrange an interest rate swap which is essentially a forward contract in which a certain stream of future cash flows are exchanged for another. Other options will not reduce the interest rate risk of the bank,