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Hi tutor,
Does gap exposure actually mean that “interest rates on deposits and on loan are revised at different times”? I thought this was the problem of basis risk 🙁
This statement was taken from BPP revision kit (2014 edition) MCQ 100.1
Surprisingly BPP study text stated that gap exposure arises when interest sensitive liabilities exceed interest sensitive assets with interest rates increasing. And did not mention anything about that first statement I wrote.
They did include that statement under basis risk however. That 2 interest rates may move at different times or by different amounts.
Gap exposure has nothing to do with basis risk.
If you borrow money you will pay interest, and if you have money on deposit you will receive interest. The interest banks pay on deposits is lower than the interest that they charge on borrowings (because they make a profit on the difference). That is what the gap is, and if interest rates overall go up then this gap/difference gets bigger.
(Basis risk is something completely different – it is the difference between the actual interest rate and the equivalent interest rate on the future. I would not worry too much about that 🙂 )
That’s a relief.. Thanks for the help 🙂
Also, I read that exchange traded currency options are negotiable while over the counter currency options aren’t. Meanwhile in the money and capital markets chapter, the study text wrote that exchange traded securities are non negotiable while over the counter securities can be negotiable or non negotiable.
Negotiable means the security can be traded before maturity while non negotiable securities can’t
Is the above correct?
All you have written is correct, except for the fact that traded securities are negotiable (by definition). If you have copied it correctly then it seems there is a typing mistake wherever you read it.
Thank you 🙂 just did the paper, it was pretty OK, thanks John for the help all this while 🙂 🙂
Anyway in the exam there was a question on irredeemable bonds:If interest rates rise, the market value of bonds will rise so investors will have a higher yield
Or
If interest rates fall, the market value of bonds will fall so investors will have a higher yield
Which option would be correct?
Errr…. neither of the two options you have written are correct 🙂
I am pleased that the exam was OK for you.
Oh I’m sorry- what I meant to write was
“if interest rates rise, the market value will fall so investors will receive a higher yield”
“If interest rates rise, the market value will rise so investors will receive a higher yield”
“If interest rates rise, the market value will rise so investors will receive a reduced yield”
“If interest rates rise, the market value will fall so investors will receive a reduced yield”
Which would be the correct one?
The first one: “if interest rates rise, the market value will fall so investors will receive a higher yield”
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