Chapter 25: Treasury and Asset-Liability Management (CAIIB – Paper 2)
1. What is the primary objective of Asset-Liability Management (ALM) in banks?
A. Maximizing customer satisfaction
B. Reducing staff expenses
C. Managing risks arising out of mismatches between assets and liabilities
D. Improving branch-level marketing
ALM focuses on managing liquidity risk, interest rate risk, and other mismatches between assets and liabilities to ensure stability and profitability of banks.
2. In the context of ALM, which of the following is considered a liability for a bank?
A. Customer deposits
B. Loans and advances
C. Investments in government securities
D. Cash balance with RBI
Deposits are liabilities of banks because banks are obligated to repay them to customers. Loans and investments are considered assets.
3. Which of the following risks is NOT directly managed through ALM?
A. Liquidity risk
B. Interest rate risk
C. Currency risk
D. Reputational risk
ALM primarily deals with balance sheet risks such as liquidity, interest rate, and currency risks. Reputational risk is not managed through ALM directly.
4. Which committee’s recommendations led to the introduction of formal ALM systems in Indian banks?
A. Malegam Committee
B. Narasimham Committee
C. Rangarajan Committee
D. Kelkar Committee
The Narasimham Committee recommended the implementation of ALM practices in Indian banks to strengthen financial stability and risk management.
5. The process of ALM in banks is primarily designed to balance:
A. Income and expenditure of the bank
B. Staff strength across branches
C. Risk and return through optimal management of assets and liabilities
D. Number of loans and deposits accounts
ALM ensures that the bank manages its assets and liabilities in a way that optimizes returns while controlling risks like liquidity and interest rate risk.
6. Liquidity risk in banks primarily refers to:
A. Risk of decrease in interest income due to falling rates
B. Risk of borrower default on loan repayment
C. Risk of fluctuation in exchange rates
D. Risk that a bank may not be able to meet its short-term obligations when they fall due
Liquidity risk arises when a bank cannot generate sufficient cash flow or liquid assets to meet its obligations such as withdrawals or loan disbursements.
7. A sudden withdrawal of large deposits by customers can expose a bank to which type of risk?
A. Market risk
B. Liquidity risk
C. Credit risk
D. Operational risk
Unexpected deposit withdrawals affect a bank’s ability to maintain required liquidity, hence exposing it to liquidity risk.
8. Interest rate risk in banking mainly arises due to:
A. Mismatches in the maturity and repricing of assets and liabilities
B. Borrowers not repaying their loans
C. High operational expenses
D. Fluctuations in foreign currency exchange rates
Interest rate risk occurs when changes in market interest rates affect the bank’s earnings or the economic value of its assets and liabilities due to mismatched repricing.
9. Which of the following is an example of interest rate risk affecting a bank?
A. Customer defaults on loan repayment
B. Fraudulent transaction by staff
C. Fall in bond prices due to increase in interest rates
D. Sudden withdrawal of deposits by customers
Bond prices move inversely with interest rates. When interest rates rise, bond values fall, exposing banks to interest rate risk on their investment portfolios.
10. In ALM, the technique used to measure interest rate risk by analyzing the difference between rate-sensitive assets and rate-sensitive liabilities is called:
A. Gap Analysis
B. Duration Analysis
C. Scenario Analysis
D. Simulation Analysis
Gap analysis is a traditional tool to measure interest rate risk by comparing rate-sensitive assets (RSA) and rate-sensitive liabilities (RSL) in different time buckets.
11. What is the primary role of the Treasury Department in Asset-Liability Management (ALM)?
A. Conducting staff training and HR management
B. Managing liquidity, funding, and market risks to support ALM objectives
C. Handling branch-level customer queries
D. Monitoring frauds and operational losses
The Treasury Department plays a critical role in ALM by managing liquidity, funding requirements, interest rate exposure, and market risks.
12. Which of the following best describes how Treasury supports liquidity management?
A. By monitoring employee turnover
B. By investing in IT infrastructure
C. By ensuring the bank has adequate liquid assets to meet short-term obligations
D. By conducting internal audits
Treasury ensures sufficient cash reserves, government securities, and other liquid assets are maintained to meet outflows and regulatory requirements.
13. Which of the following derivatives is commonly used by banks to hedge interest rate risk under ALM?
A. Interest Rate Swaps
B. Credit Default Swaps
C. Commodity Futures
D. Equity Options
Interest Rate Swaps allow banks to exchange fixed and floating rate obligations, thereby managing mismatches in interest-sensitive assets and liabilities.
14. A bank expects interest rates to rise. Which derivative strategy can it use to protect its bond portfolio value?
A. Entering into a forward purchase of bonds
B. Writing a call option on bonds
C. Entering into a fixed-to-floating interest rate swap
D. Buying interest rate futures to hedge against rising yields
By buying interest rate futures, the bank hedges against rising yields (falling bond prices), thus protecting its bond portfolio value.
15. How do derivatives support ALM in banks?
A. By increasing the volume of customer deposits
B. By reducing staff costs
C. By hedging risks related to interest rates, liquidity, and foreign exchange exposures
D. By replacing regulatory capital requirements
Derivatives such as swaps, forwards, options, and futures help banks manage risks in interest rate movements, liquidity mismatches, and forex fluctuations, thereby strengthening ALM.
16. Credit risk in banks primarily refers to:
A. Risk of loss due to a borrower’s failure to meet obligations
B. Risk of changes in market interest rates
C. Risk of inadequate liquidity to meet obligations
D. Risk of operational failures in processes
Credit risk arises when borrowers or counterparties fail to meet their financial commitments, leading to losses for the bank.
17. Which of the following is an example of credit risk for a bank?
A. Bond price fluctuations due to interest rate changes
B. Rupee depreciation against the dollar
C. Maturity mismatch between assets and liabilities
D. Borrower defaulting on loan repayment
Credit risk directly relates to the possibility of borrowers defaulting on their obligations, such as non-repayment of loans or interest.
18. Credit derivatives are mainly used for:
A. Enhancing branch profitability
B. Transferring or hedging credit risk exposure
C. Increasing employee efficiency
D. Reducing operational overheads
Credit derivatives allow banks to transfer credit risk of an asset without actually selling the asset, providing an important risk management tool.
19. Which of the following is the most commonly used credit derivative?
A. Forward Rate Agreement (FRA)
B. Currency Swap
C. Credit Default Swap (CDS)
D. Interest Rate Option
A Credit Default Swap (CDS) is the most widely used credit derivative, where the buyer of protection pays a premium to transfer credit risk to the seller.
20. In a Credit Default Swap (CDS), who compensates the loss if the borrower defaults?
A. The borrower itself
B. The regulator (RBI)
C. The CDS buyer
D. The CDS seller
In a CDS, the seller of protection compensates the buyer if the borrower (reference entity) defaults, thereby transferring credit risk.
21. In the context of ALM, transfer pricing in banks refers to:
A. Pricing of export-import transactions
B. Pricing of cross-border remittances
C. Internal allocation of costs and benefits of funds between business units
D. Setting interest rates for retail borrowers
Transfer pricing is an internal mechanism to assign a cost or benefit of funds across different units of the bank, ensuring proper measurement of profitability.
22. The main purpose of transfer pricing in ALM is to:
A. Align performance measurement of different business units with overall bank strategy
B. Increase customer acquisition
C. Reduce HR expenses
D. Comply with taxation requirements
Transfer pricing allows correct attribution of costs and revenues across units, ensuring that each business segment’s performance is fairly evaluated.
23. In a bank, which department usually acts as the central unit for implementing transfer pricing?
A. Credit Monitoring Department
B. Treasury Department
C. Internal Audit Department
D. Marketing Department
The Treasury Department plays the role of central fund manager and implements transfer pricing by allocating cost of funds and liquidity premiums across units.
24. The policy environment for ALM in banks is largely influenced by:
A. Branch-level competition
B. Employee performance reviews
C. Customer feedback surveys
D. Regulatory guidelines issued by RBI and international standards like Basel norms
Policy environment for ALM is guided by RBI’s regulatory framework, Basel III guidelines, and international best practices for risk management.
25. Which of the following best describes the impact of policy environment on ALM?
A. It sets targets for branch-level marketing
B. It controls HR policies of banks
C. It defines regulatory requirements and prudential norms for managing risks in banks
D. It increases profitability of banks automatically
The policy environment provides the regulatory and prudential framework within which ALM must operate, including limits on risk exposures, liquidity requirements, and capital adequacy.
26. Caselet: A bank’s Treasury fixes the internal transfer pricing rate at 6% p.a. for deposits and 9% p.a. for advances.
If the Retail Banking division mobilizes ₹100 crore deposits and the Corporate Credit division lends ₹100 crore, what will be the internal credit to Retail Banking and cost to Corporate Credit?
A. Credit ₹9 crore to Retail; Cost ₹6 crore to Corporate
B. Credit ₹6 crore to Retail; Cost ₹9 crore to Corporate
C. Credit ₹3 crore to Retail; Cost ₹3 crore to Corporate
D. No impact on either division
FTP rewards deposit mobilization by crediting Retail Banking with interest at 6% (₹6 crore) and charges Corporate Credit with cost of funds at 9% (₹9 crore).
27. Numerical: A bank has liquid assets of ₹500 crore and volatile liabilities of ₹1,000 crore.
What is the Liquidity Coverage Ratio (LCR)?
28. Caselet: A bank’s ALM committee observes rising interest rates. To mitigate risk, the Treasury decides to use Interest Rate Swaps (IRS).
Which action is most suitable if the bank has fixed-rate assets and floating-rate liabilities?
A. Enter into a swap to receive floating and pay fixed
B. Enter into a swap to pay floating and receive fixed
C. Sell government securities
D. Increase CRR balances
Since liabilities are floating (higher cost in rising rates) and assets are fixed, the bank should receive floating and pay fixed through an IRS to balance exposures.
29. Numerical: A bank’s NII (Net Interest Income) is ₹200 crore. If interest-sensitive assets of ₹5,000 crore and liabilities of ₹4,500 crore re-price after 1 year, and interest rates rise by 1%, what is the change in NII?
A. Decrease of ₹5 crore
B. Decrease of ₹10 crore
C. Increase of ₹10 crore
D. Increase of ₹5 crore
GAP = 5,000 – 4,500 = ₹500 crore (positive gap).
Impact = GAP × Change in rate = 500 × 1% = ₹5 crore increase in NII.
30. Caselet: RBI introduces a stricter liquidity coverage requirement. Which ALM strategy should the Treasury adopt?
A. Increase long-term lending
B. Increase holdings of High Quality Liquid Assets (HQLA)
C. Reduce CASA deposits
D. Increase unsecured borrowings
To meet higher LCR requirements, banks must hold more HQLA (e.g., cash, government securities).
