Which of the following risks are addressed by Asset Liability Management ?

Solution

Although ALM frameworks differ greatly among organizations, they typically involve the mitigation of a wide range is risks. Some of the most common risks addressed by ALM are interest rate risk and liquidity risk. Interest Rate Risk Interest rate risk refers to risks associated with changes to interest rates, and how changing interest rates affect future cash flows. Financial institutions typically hold assets and liabilities that are affected by changing interest rates. Two of the most common examples are deposits (assets) and loans (liabilities). As both are impacted by interest rates, an environment where rates are changing can result in a mismatching of assets and liabilities. Liquidity Risk Liquidity risk refers to risks associated with a financial institutionrsquo;s ability to facilitate itrsquo;s present and future cash-flow obligations, also known as liquidity. When the financial institution is unable to meet its obligations due to a shortage of liquidity, the risk is that it will adversely affect its financial position. To mitigate the liquidity risk, organizations may implement ALM procedures to increase liquidity to fulfill cash-flow obligations resulting from their liabilitiesOther Types of Risk Aside from interest and liquidity risks, other types of risks are also mitigated through ALM. One example is currency risk, which are risks associated with changes to exchange rates. When assets and liabilities are held in different currencies, a change in exchange rates can result in a mismatch. Another example is capital market risk, which are risks associated with changing equity prices. Such risks are often mitigated through futures, options, or derivatives.