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Market Guides > Gap reports - how do you use them?

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Published: 14th October 2009 by William Webster

Gap reports show you the interest rate risk you are running in your balance sheet. They put the assets and liabilities into time buckets in accordance with their interest rate repricing.

From this simple approach you can obtain a table or graph of the risk being run. This normally includes a profit and loss figure that results from moving the yield curve. Gap limits are also applied in order to keep the interest rate exposure within risk tolerence.

Gap reports aren't new; they are widely used and have both strengths and weaknesses. Let's find out more.

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Document Summary

What a gap report shows. Quantifying the risk. What happens if the yield curve moves? Hedging the risk. Match funding. Swaps. What hedging does to the gap. When to hedge. Limits on the gap. Strengths and weaknesses of the gap report. Options, pre-payments, changes to the shape of the yield curve, basis risk. Should you use gap reports?

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14th October 2009

Gap reports are frequently used in firms to show the extent of the interest rate risk that is being run. They are sometimes referred to as interest rate repricing reports. If you look at the assets (investments) and the liabilities (funding) in a bank or building society balance sheet it is most unlikely that they will all be on the same interest basis. Some assets and liabilities are floating or variable rate. This means they are linked to Libor or Base rate. Some assets and liabilities are fixed rate. As a result the balance sheet will have a mixture of fixed rate and floating rate interest payments and receipts. When this happens the firm is exposed to a type of market risk called interest rate risk. When interest rates change the value of the balance sheet can alter. It may work in your favour it may work against you. The main difficulty is the uncertainty you face and that's something you need to manage. A gap report measures this risk. Let's see how.

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