Post Graduate Program in Banking
Treasury & Asset Liability Management
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Post Graduate
Treasury and ALM Foundations
Introduction and context
Banking is an exercise in transforming risk across time, liquidity, geography and counterparties. Banks accept deposits and other short-term liabilities, provide loans and investments with a range of maturities, operate payment systems, trade financial instruments, and maintain capital to absorb unexpected losses. These activities create a fundamental management problem: cash inflows, cash outflows, asset returns, funding costs and risk exposures do not occur at the same time or with the same certainty.
Treasury and asset liability management (ALM) provide the institutional framework for managing this problem. Treasury traditionally concentrates on liquidity, funding, market operations, cash management and financial-market execution. ALM takes a broader balance-sheet perspective, examining how the structure and behaviour of assets, liabilities and capital affect earnings, liquidity and solvency. In modern banks the two functions are closely connected, although their precise division varies by institution and regulation.
The central managerial challenge is not to eliminate risk. A bank that eliminated all maturity, interest-rate and credit risk would perform little economically useful intermediation. The challenge is to accept risks deliberately, price them appropriately, fund them reliably, monitor them continuously and keep them within the bank's capacity to absorb losses.
Learning objectives
By the end of this chapter, the reader should be able to:
Explain the mandate and principal activities of a bank treasury.
Distinguish asset liability management from treasury dealing and from enterprise-wide risk management.
Define essential ALM terminology, including repricing gap, duration, liquidity risk, funding risk, market risk, capital and solvency.
Compare banking-book and trading-book activities and explain why their risk-management methods differ.
Describe alternative treasury and ALM organizational structures.
Explain the role, authority and responsibilities of the Asset-Liability Committee (ALCO).
Analyse the relationship among risk, return, liquidity and solvency.
Apply these concepts to a practical banking scenario and identify appropriate governance responses.
1. The treasury mandate
A treasury function is commonly mandated to ensure that the bank can meet its obligations when due, obtain funding at an acceptable cost, manage financial-market exposures within approved limits, and support the balance-sheet strategy approved by the board. This mandate contains four related dimensions.
Liquidity and funding
Liquidity is the ability to obtain cash, or convert assets into cash, quickly and at acceptable cost. Funding liquidity concerns the ability to meet contractual and expected cash outflows. Market liquidity concerns the ability to sell or finance an asset without materially affecting its price. A security may be easy to sell in normal conditions but difficult to liquidate during a market crisis; therefore liquidity must be assessed under stress rather than only under ordinary conditions.
Treasury manages cash positions, reserve balances, wholesale borrowing, collateral, secured funding, central-bank facilities and contingency funding arrangements. It also monitors concentrations by funding source, maturity, currency, counterparty and market.
Financial-market execution
Treasury may execute transactions in money markets, foreign exchange, securities and derivatives. Execution may support funding, liquidity hedging, interest-rate management, foreign-exchange risk management or customer activity. A dealing mandate should specify permitted instruments, currencies, maturities, counterparties, position limits, stop-loss limits and escalation requirements.
Balance-sheet support
Treasury translates the bank's strategic objectives into funding and hedging actions. For example, rapid growth in fixed-rate mortgages may create long-term interest-rate exposure and funding needs. Treasury may respond through term funding, interest-rate swaps, securities purchases or changes in product pricing. It should not, however, use trading activity to conceal structural weaknesses in the balance sheet.
Financial control and information
Treasury supplies management with timely information on cash, funding costs, liquidity buffers, market exposures, collateral and forecast cash flows. Independent control functions validate valuations, monitor limits, confirm transactions and report breaches. The treasury mandate is therefore both operational and governance-related.
A sound mandate is explicit about what treasury is not authorised to do. Treasury should not originate credit without proper approval, assume unpriced risks for speculative purposes, bypass independent valuation, or treat regulatory liquidity assets as freely available for routine profit generation.
2. ALM as a balance-sheet discipline
ALM is the coordinated management of assets, liabilities and capital so that the bank can pursue its objectives while controlling interest-rate, liquidity, market, structural foreign-exchange and related risks. ALM is not merely a report showing maturity mismatches. It is a decision framework connecting products, pricing, funding, capital and risk appetite.
The balance sheet provides the starting point:
Assets = Liabilities + Equity
Assets include cash, loans, securities and derivatives with positive value. Liabilities include deposits, borrowings and issued debt. Equity, or regulatory capital in a prudential context, represents the residual claim and an important loss-absorbing resource. The identity is an accounting relationship, not a statement that assets and liabilities have equal economic risk or liquidity.
ALM asks questions such as:
How much of the asset portfolio reprices when market rates change?
How stable are deposits during stress?
What cash outflows arise if wholesale funding cannot be rolled over?
How much capital is available after adverse credit, market and operational events?
Are product prices sufficient to compensate for funding, liquidity, capital and expected-loss costs?
Important terminology
Term
Meaning
Asset-liability mismatch
Difference between the cash-flow, repricing, currency or behavioural characteristics of assets and liabilities.
Repricing gap
Rate-sensitive assets minus rate-sensitive liabilities for a specified time bucket.
Liquidity buffer
High-quality liquid assets and other immediately available resources held to meet stressed cash needs.
Funding liquidity risk
Risk that obligations cannot be paid when due.
Market liquidity risk
Risk that an asset cannot be sold or financed at close to its observed market value.
Structural interest-rate risk
Exposure arising from the banking book's asset, liability and off-balance-sheet structure.
Basis risk
Risk that related interest rates or indices do not move together as expected.
Optionality
Risk created by customers' or counterparties' ability to alter contractual cash flows, such as prepayment or deposit withdrawal.
Embedded option
An option contained within a product rather than traded separately.
Transfer pricing
Internal allocation of funding, liquidity, capital and risk costs to business units or products.
Economic value
Present value of expected future cash flows, usually adjusted for risk and market prices.
Net interest income
Interest earned on assets minus interest paid on liabilities, generally before relevant provisions and operating costs.
Economic capital
Internal estimate of capital required to absorb unexpected loss at a chosen confidence level and horizon.
Regulatory capital
Capital recognised under applicable prudential rules.
Solvency
Capacity to absorb losses such that liabilities can continue to be honoured and the institution remains viable.
3. Banking book and trading book
The banking book generally contains positions intended to earn contractual cash flows or to support relationship banking. Loans, ordinary deposits, many investment securities and structural hedges are typical examples. Its central risks are credit risk, structural interest-rate risk, liquidity risk and behavioural uncertainty. Measurement often emphasises net interest income, economic value, expected loss, capital consumption and stressed cash flows.
The trading book contains positions held for short-term resale, market-making, arbitrage or hedging of trading positions. It is managed actively and marked to market or an appropriate valuation basis. Its central risks include price volatility, spread risk, foreign-exchange risk, counterparty risk, model risk and market liquidity risk. Trading-book performance is normally evaluated through daily profit and loss, sensitivities, stress tests and risk-adjusted limits.
The distinction is economic and governed by policy; it is not simply a matter of where an instrument is recorded. Reclassifying a position to obtain a favourable capital or earnings treatment is a serious governance failure. Clear entry criteria, documentation, independent validation and regulatory compliance are required.
Comparison of banking-book and trading-book management
Dimension
Banking book
Trading book
Primary intention
Relationship intermediation and contractual cash flows
Short-term resale, market-making or trading
Main performance lens
Net interest income, economic value and credit-adjusted return
Daily profit and loss, market value and risk-adjusted trading return
Typical risks
Credit, liquidity, repricing and behavioural risk
Market, spread, counterparty, model and liquidity risk
Valuation emphasis
Accrual and economic-value analysis, subject to accounting rules
Frequent market-based valuation and independent price verification
Horizon
Often medium to long term
Generally short term and actively managed
Key controls
ALM limits, liquidity ratios, stress tests and capital allocation
Position limits, sensitivities, stop-loss, valuation and conduct controls
The boundary can be difficult in securities portfolios, derivatives and structured products. A derivative used to hedge a banking-book exposure may be managed by treasury, while a similar instrument held for market-making belongs to trading activities. The purpose, risk management process and evidence of intent are therefore essential.
4. Core ALM measurement concepts
Repricing gaps
A simple repricing gap for time bucket i is:
Gi = RSAi − RSLi
where Gi is the gap in bucket i, RSAi is the value of rate-sensitive assets repricing in that bucket, and RSLi is the value of rate-sensitive liabilities repricing in that bucket. The units are currency units. The measure assumes that items in the bucket are treated as repricing at the bucket boundary or according to an agreed convention.
If rates rise by approximately ∆r and all rate-sensitive items reprice immediately and equally, the approximate change in net interest income is:
∆NIIi ≈ Gi × ∆r
Here ∆NIIi is the change in interest income over the chosen measurement period, ∆r is the annualised rate change expressed as a decimal, and the result applies only when the period convention is consistent. For a three-month period, a more explicit approximation is:
∆NIIi ≈ Gi × ∆r × 3/12
This is a simplified static-gap model. It ignores basis risk, deposit behaviour, prepayments, new business, credit deterioration, nonlinear options and different repricing speeds. It is useful for first-order diagnosis, not as a complete risk model.
Duration and economic value
For fixed-income instruments, duration measures sensitivity of price to a small change in yield. Modified duration gives the first-order approximation:
∆P/P ≈ −Dmod × ∆y
where P is price, Dmod is modified duration in years, and ∆y is the change in yield expressed as a decimal. The approximation assumes a small parallel yield shift and ignores convexity. The negative sign indicates that price normally falls when yield rises.
For a portfolio, duration-based analysis can estimate the change in the economic value of equity (EVE), which is the present value of assets minus the present value of liabilities and relevant off-balance-sheet cash flows. It is particularly useful for long-term structural interest-rate risk. However, a bank's deposits may have uncertain maturity and customer options may make duration unstable.
Liquidity gap and survival horizon
A liquidity gap compares expected inflows and outflows across time buckets. A simplified cumulative gap is:
CGt = ∑(Inflowsk − Outflowsk), k = 1 to t
where CGt is the cumulative cash-flow gap through time t. A negative value indicates that identified outflows exceed inflows before considering available liquid assets or funding actions. The calculation depends heavily on assumptions about deposit run-off, collateral calls, loan drawdowns, asset sales and market access.
A survival horizon is the length of time the bank can meet stressed net cash outflows using available liquidity resources without relying on unsecured market access. Because it depends on scenarios and management actions, it is a risk indicator rather than an accounting identity.
Risk-adjusted return
A basic return measure is insufficient if two businesses use different amounts of capital or liquidity. A simplified risk-adjusted return on capital can be represented as:
RAROC = (Expected revenue − Expected loss − Operating cost − Liquidity cost) / Economic capital
The numerator and denominator must refer to the same period and currency basis. Expected loss is not the same as unexpected loss: expected loss is normally priced or provisioned, while economic capital is intended to absorb adverse deviations from expectation. Actual institutional formulas may include tax, transfer pricing, capital charges and diversification effects.
5. Organizational structures
Treasury and ALM structures differ according to bank size, business model, regulation and market complexity.
Centralised treasury
A centralised treasury controls funding, liquidity, market execution and often the internal funds-transfer-pricing framework. Business units originate loans and deposits but treasury manages the resulting structural exposures. This arrangement offers strong control, consistent pricing and efficient market access. Its weakness is that business units may ignore the liquidity and interest-rate consequences of their decisions unless transfer prices are credible.
Decentralised treasury
In a decentralised model, business lines retain greater responsibility for funding and risk management. This may improve commercial responsiveness and product expertise, but it can create duplicated infrastructure, inconsistent limits and hidden correlations. Strong group-wide aggregation is essential.
Hybrid model
Most substantial banks use a hybrid structure. Group treasury controls liquidity, capital markets access, structural hedging and policy. Specialist desks or subsidiaries manage local requirements within delegated limits. A central ALCO sets policy, while local committees address entity-specific conditions.
A robust structure separates:
Risk taking — business units and authorised dealers.
Risk control — independent risk management and treasury control.
Risk assurance — internal audit and, where relevant, external assurance.
Governance — board, board risk committee, ALCO and executive management.
The first line owns risks, the second line challenges and monitors them, and the third line independently assesses the effectiveness of governance and controls. Reporting lines should prevent a dealer or business head from approving, valuing and independently confirming the same transaction.
6. ALCO responsibilities and decision rights
ALCO is the senior management forum responsible for balance-sheet risk and financial structure. It is usually chaired by a senior executive such as the chief financial officer, chief risk officer or treasurer, depending on the bank's governance design. Membership commonly includes treasury, finance, risk, business heads, funding, credit, markets and regulatory affairs.
ALCO should have a written charter covering membership, quorum, voting or decision rules, delegated authority, meeting frequency, information requirements and escalation procedures. Its responsibilities normally include:
recommending or implementing the board-approved risk appetite;
approving ALM policies, limits and measurement conventions within delegated authority;
reviewing liquidity, funding concentration and contingency funding plans;
deciding the composition and usability of the liquidity buffer;
reviewing interest-rate risk in the banking book and structural foreign-exchange risk;
evaluating funding plans, issuance schedules and collateral capacity;
approving transfer-pricing principles and reviewing product profitability;
examining stress tests, reverse stress tests and management actions;
monitoring capital adequacy, leverage and the interaction between capital and liquidity;
challenging assumptions about deposit stability, prepayments, loan growth and market access;
escalating material breaches, emerging risks and limit changes to the appropriate board committee.
ALCO should not become a forum that merely receives reports. Effective challenge requires alternative scenarios, sensitivity analysis, clear ownership of actions and documented follow-up. Minutes should record decisions, assumptions, dissenting views and deadlines.
Risk appetite and limits
Risk appetite expresses the amount and type of risk the bank is willing to accept in pursuit of its strategy. It may include limits on liquidity coverage, funding concentration, wholesale dependence, cumulative cash-flow gaps, earnings sensitivity, EVE sensitivity, currency positions, capital ratios and stress losses. Limits should be measurable, forward-looking and linked to escalation levels.
A limit is not a target. Operating below a limit does not prove that risk is appropriate; management should maintain headroom for uncertainty, model error and deteriorating market conditions.
7. The relationship between risk, return, liquidity and solvency
These four concepts are interconnected but not interchangeable.
Risk is the possibility that actual outcomes differ adversely from expectations. It includes credit, market, liquidity, operational, legal, model and conduct risk.
Return is the compensation generated by accepting risk. In banking it may include interest income, fees, trading income and valuation gains, net of funding, operating and expected-loss costs.
Liquidity concerns the timing and convertibility of cash. A profitable bank can fail if it cannot meet payments today.
Solvency concerns the capacity to absorb losses over time. A bank may be liquid today but insolvent economically if the value of its assets is below its liabilities. Conversely, a solvent bank can experience a temporary liquidity crisis if assets are difficult to monetise or funding markets close.
The relationship can be expressed conceptually as follows:
Conceptual relationship among risk, return, liquidity and solvency
Figure: Conceptual relationship among risk, return, liquidity and solvency
Figure: ALCO integrates risk appetite with return, liquidity and solvency decisions.
Higher-yielding assets often carry greater credit, duration or liquidity risk. Funding that is cheaper but short term may increase refinancing risk. Holding more liquid assets generally reduces return because highly liquid instruments often yield less than loans or less liquid securities. More capital improves loss-absorption capacity but may reduce measured return on equity unless it supports safer and more sustainable growth. These are not automatic laws; they are trade-offs requiring scenario analysis and strategic judgement.
8. Illustrative case: Meridian Commercial Bank
Background
Meridian Commercial Bank is a fictional mid-sized bank with a rapidly growing mortgage portfolio. It funds much of its balance sheet with retail deposits and three-month wholesale certificates. Mortgages are predominantly fixed rate for five years, while wholesale certificates reprice every three months. Management reports strong current profitability.
Problem
A 200-basis-point increase in market rates is expected. Deposit rates may rise gradually, but wholesale funding will reprice immediately. Some borrowers may prepay, while others will remain locked into low-rate mortgages. At the same time, a market shock could reduce the availability of wholesale refinancing.
Analysis
Meridian has a positive long-term fixed-rate asset exposure and a short-term funding concentration. Its simple repricing gap is likely negative in the short buckets because liabilities reprice sooner than mortgage assets. Its five-year economic value may also decline if the present value of fixed-rate assets falls more than the present value of liabilities. The bank faces both earnings sensitivity and economic-value sensitivity.
The liquidity issue is separate but connected. Even if assets remain economically valuable, the bank must refinance certificates as they mature. A failure of wholesale markets would create a funding liquidity problem. Selling mortgages or securities during stressed conditions could generate losses and weaken capital.
Approach and solution
ALCO should first validate assumptions and quantify several scenarios, including parallel rate increases, curve steepening, deposit migration, wholesale market closure, mortgage prepayment changes and collateral haircuts. It should then consider a package rather than a single action:
lengthen a portion of wholesale funding maturities;
increase stable deposit and committed funding sources;
maintain an appropriately sized unencumbered liquidity buffer;
hedge a measured portion of fixed-rate exposure using approved derivatives;
review mortgage pricing, prepayment assumptions and early-redemption economics;
allocate liquidity and capital costs through transfer pricing;
establish triggers for reducing asset growth if funding conditions deteriorate;
document hedge effectiveness, counterparty limits and collateral requirements.
The bank should not hedge mechanically without considering basis risk, hedge cost, collateral calls and the possibility that customer behaviour changes. Nor should it solve the problem by concentrating in a single funding market.
Outcome
In this illustrative case, Meridian reduces its short-term refinancing concentration, improves its stressed survival horizon and narrows its interest-rate exposure. Reported short-term earnings decline modestly because longer funding and hedging are more expensive. However, the bank's risk-adjusted return improves because the probability and severity of liquidity and capital stress are reduced.
Learning points
Current profit does not demonstrate sustainable balance-sheet strength.
Repricing risk and liquidity risk are distinct but can reinforce each other.
Hedging transfers or reshapes risk; it does not make risk disappear.
ALCO decisions must consider earnings, economic value, cash survival and capital together.
Funding diversification and contingency preparation are strategic capabilities, not emergency activities only.
9. Governance, regulation and ethical considerations
Treasury and ALM are heavily governed because individual institutions can create systemic consequences. Relevant prudential frameworks commonly address liquidity buffers, stable funding, capital adequacy, leverage, large exposures, market risk, stress testing and governance. Exact requirements vary by jurisdiction and should be read with current local rules.
Good governance requires accurate data lineage, independent valuation, model validation, documented assumptions and prompt breach escalation. Models of deposit decay, loan prepayment, collateral liquidity and stress outflows should be subject to back-testing and sensitivity analysis. Management should understand model limitations rather than treating model outputs as facts.
Ethical issues arise when performance is reported without risk costs, when liquidity buffers are used to enhance short-term returns without proper authority, when transfer prices subsidise aggressive growth, or when customers are sold products whose risks are poorly understood. Remuneration should discourage excessive maturity transformation and short-term revenue seeking. Senior managers remain accountable even when activities are delegated to specialists or automated systems.
Technology can improve intraday cash monitoring, data aggregation, scenario generation and limit alerts. Artificial intelligence may assist forecasting of deposit behaviour or anomaly detection, but it introduces explainability, data-quality, model-drift, privacy and conduct concerns. AI outputs should support, not replace, expert judgement, independent validation and accountable governance.
10. Best-practice principles
A professionally managed treasury and ALM framework should:
begin with a board-approved risk appetite and clearly delegated mandates;
distinguish banking-book, trading-book and hedging activities;
use multiple measures, including cash-flow, earnings, economic-value and capital perspectives;
incorporate behavioural assumptions and stress scenarios;
maintain a genuinely usable liquidity buffer and diversified funding plan;
charge business lines for funding, liquidity, capital and risk through transparent transfer pricing;
separate dealing, confirmation, valuation, risk control and audit;
set limits with early-warning triggers and credible escalation;
test contingency funding plans through simulations and operational rehearsals;
review assumptions after market events, product changes and regulatory developments;
record ALCO decisions, ownership and completion dates;
align incentives with sustainable risk-adjusted performance.
Chapter Summary
Treasury is the bank's operational and strategic centre for liquidity, funding, financial-market execution and balance-sheet support. ALM extends this perspective by coordinating assets, liabilities and capital over time. Its purpose is not to remove all risk but to ensure that accepted risks are understood, priced, funded, hedged and kept within the institution's loss-absorbing capacity.
The banking book is primarily associated with relationship intermediation and structural risks such as credit, repricing, liquidity and behavioural risk. The trading book is actively managed for short-term resale, market-making or arbitrage and is more directly exposed to market-value volatility. Repricing gaps, duration, liquidity gaps, stress tests and risk-adjusted returns provide complementary—not interchangeable—views of exposure.
ALCO converts strategy and risk appetite into decisions about funding, liquidity buffers, hedging, product pricing, capital and escalation. Effective ALCO governance requires independent challenge, reliable data, realistic behavioural assumptions and documented management actions. Risk, return, liquidity and solvency must be evaluated together: profitability without liquidity can end in failure, and liquidity without solvency is not sustainable. The essential foundation of treasury and ALM is therefore integrated, forward-looking balance-sheet governance.
Key Terms
Treasury: Function responsible for liquidity, funding, market execution and related balance-sheet activities.
Asset-liability management: Coordinated management of assets, liabilities and capital to control balance-sheet risks.
ALCO: Senior management committee overseeing balance-sheet structure and ALM risks.
Banking book: Positions held mainly for relationship banking and contractual cash flows.
Trading book: Positions held for short-term resale, market-making or trading purposes.
Liquidity: Ability to meet obligations by obtaining cash or converting assets at acceptable cost.
Funding liquidity risk: Risk of inability to meet obligations when due.
Market liquidity risk: Risk of being unable to sell or finance an asset without significant price impact.
Repricing gap: Rate-sensitive assets minus rate-sensitive liabilities in a defined time bucket.
Duration: Measure of sensitivity of an instrument's or portfolio's value to yield changes.
Basis risk: Risk that related rates or indices move differently from expected.
Optionality: Uncertainty created by a contractual party's ability to change cash flows.
Transfer pricing: Internal allocation of funding, liquidity, capital and risk costs.
Net interest income: Interest income less interest expense.
Economic value of equity: Present value of assets less present value of liabilities and relevant off-balance-sheet items.
Risk appetite: Amount and types of risk an institution is willing to accept.
Liquidity buffer: Assets and resources available to meet stressed cash needs.
Solvency: Capacity to absorb losses and remain viable while honouring obligations.
Economic capital: Internal capital estimate for absorbing unexpected losses.
Stress testing: Analysis of outcomes under adverse but plausible scenarios.
Review Questions
5 Short Answer Questions
What are the principal responsibilities of a bank treasury?
Define a repricing gap and state one limitation of simple gap analysis.
How does the banking book differ from the trading book?
What is the purpose of a liquidity buffer?
Why must ALCO consider both liquidity and solvency?
5 Long Answer Questions
Explain the treasury mandate and its relationship with enterprise risk management.
Compare centralised, decentralised and hybrid treasury structures, including their advantages and weaknesses.
Discuss the responsibilities, authority and governance requirements of ALCO.
Explain how risk, return, liquidity and solvency interact in bank decision-making.
Evaluate the usefulness and limitations of repricing-gap and duration-based ALM techniques.
3 Analytical / Application Questions
A bank funds five-year fixed-rate loans with three-month wholesale borrowing. Analyse the main interest-rate and liquidity risks and recommend an ALCO response.
A business unit reports high returns but uses unstable funding and consumes substantial economic capital. Design a transfer-pricing and governance response.
During a market shock, a bank remains solvent on an economic-value basis but cannot roll over maturing wholesale debt. Explain how this can occur and formulate a contingency funding plan.
Multiple Choice Questions with Answers
Question 1
Which activity is most directly part of a bank treasury mandate?
A. Approving every retail loan application
B. Managing liquidity and funding
C. Conducting external financial audits
D. Setting national monetary policy
Correct Answer: B. Managing liquidity and funding
Question 2
A repricing gap is generally calculated as:
A. Total assets minus total liabilities
B. Cash inflows minus capital
C. Rate-sensitive assets minus rate-sensitive liabilities
D. Trading revenue minus operating expenses
Correct Answer: C. Rate-sensitive assets minus rate-sensitive liabilities
Question 3
Which position is most characteristic of the banking book?
A. A security held for short-term market-making
B. A loan held to earn contractual cash flows
C. A dealer's intraday foreign-exchange position
D. An arbitrage position intended for rapid resale
Correct Answer: B. A loan held to earn contractual cash flows
Question 4
What is the principal purpose of ALCO?
A. To coordinate balance-sheet risk and financial structure
B. To replace the internal audit function
C. To approve customer identification documents
D. To execute every securities trade personally
Correct Answer: A. To coordinate balance-sheet risk and financial structure
Question 5
If rate-sensitive assets exceed rate-sensitive liabilities in a bucket and rates rise, the simple static-gap approximation implies that:
A. Net interest income may increase in that bucket
B. Solvency automatically falls to zero
C. Liquidity risk is eliminated
D. All asset prices must rise
Correct Answer: A. Net interest income may increase in that bucket
Question 6
In the approximation ∆P/P ≈ −Dmod × ∆y, what does Dmod represent?
A. Default probability
B. Modified duration
C. Deposit maturity
D. Derivative notional
Correct Answer: B. Modified duration
Question 7
Which statement best distinguishes liquidity from solvency?
A. Liquidity concerns timely cash; solvency concerns loss-absorption capacity
B. Liquidity and solvency are identical accounting measures
C. Solvency concerns only daily cash settlements
D. Liquidity is measured only by accounting equity