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Greetings Tutor, I hope you are doing well. Can you please help me with the following.
“Gap exposure is the difference between the amounts of interest-sensitive assets and liabilities.”
1) What is meant by intrest sensitive asset and liabilities? Does this means Borrowing and investment with floating intrest rates?
2) When determining the gap exposure, do we even consider fixed interest rate asset and liabilities? Or only Floating intrest rate asset and liabilities?
Considering the fact that there will be no changes in intrest rate (when there is fixed interest) will there will be gap exposure?Interest-sensitive assets and liabilities refer to financial instruments whose values or cash flows are affected by changes in interest rates. So borrowing and investments with floating interest rates, as their interest payments can fluctuate with market rates.
When determining gap exposure, the focus is primarily on floating interest rate assets and liabilities. Fixed interest rate assets and liabilities are generally not considered in gap exposure calculations because their interest rates do not change over time. Therefore, if there are no changes in interest rates for fixed interest instruments, there would be no gap exposure arising from them.
Thankyou Tutor 🙂
Just a random thought.
If a company uses Money Market Hedging for Foreign Exchange Risk.
Which involves use of borrowing and investing (along with use of spot rate).Can we say that company would although be able to hedge Exchange Risk but would be then exposed to Intrest Rate Risk as it would be interesting and borrowing
Yes, you are correct. When a company uses Money Market Hedging to manage Foreign Exchange Risk, it involves borrowing in one currency and investing in another, typically at fixed interest rates.
While this strategy effectively hedges against exchange rate fluctuations, it does expose the company to interest rate risk. This is because changes in interest rates can affect the cost of borrowing and the returns on investments, potentially impacting the overall financial outcome of the hedging strategy.
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