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Answer: The bank models its retail non-maturity deposits as floating-rate, putable bonds.
## Explanation Option B is the most appropriate assumption because: - **Retail non-maturity deposits** (like checking and savings accounts) typically behave like floating-rate instruments where depositors have the option to withdraw funds at any time (similar to a put option) - Modeling them as floating-rate, putable bonds captures the optionality embedded in these deposits - This approach properly accounts for the behavioral characteristics of non-maturity deposits **Why the other options are incorrect:** - **Option A**: Banks typically do not pass through the full amount of market rate changes to depositors due to competitive pressures and customer relationships - **Option C**: Residential mortgages typically exhibit **negative convexity** (not positive) as interest rates decrease due to prepayment risk - borrowers are more likely to refinance when rates fall - **Option D**: Interest rate risk and credit risk in the banking book are often interrelated and should not be modeled independently, as interest rate changes can affect credit quality This question falls under **Liquidity and Treasury Risk** as it deals with modeling assumptions for interest rate risk in the banking book, which is a key component of liquidity and treasury risk management.
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The CRO of a regional bank wants to ensure that the modeling assumptions used in the bank's economic capital models are sound. The CRO asks a member of the validation team to review the bank's process of assessing the interest rate risk in its banking book and to validate the assumptions used in its interest rate models. Which of the following assumptions would be most appropriate for the bank to make?
A
The bank changes the interest rate it offers to depositors by the full amount of any change in market interest rates.
B
The bank models its retail non-maturity deposits as floating-rate, putable bonds.
C
The bank assumes that its residential mortgages exhibit positive convexity as interest rates decrease.
D
The bank models its interest rate risk in the banking book independently from its credit risk.
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