FIN.13:5.3 - A rate shock acts at resets, not on every reported balance

A constructed borrower has debt principal 100 and a deposit of 40 throughout two quarters. Each quarter has an accrual fraction of 0.25. Debt pays the reference plus 2 percentage points; the deposit pays that same reference minus 1 percentage point. Both first-quarter rates are already fixed using a reference of 4%. The second-quarter reference is uncertain. There are no floors, principal changes or other charges in this case.

At a second-quarter reference of 4%, debt interest is 1.50 in each quarter and deposit interest is 0.30 in each quarter, for net six-month interest cost 2.40. At a second-quarter reference of 6%, the first quarter stays unchanged, while second-quarter debt interest is 2 and deposit interest is 0.50. Net cost becomes 2.70, an increase of 0.30.

If the deposit instead keeps its existing rate through the second quarter, the debt’s extra 0.50 has no deposit offset then. Net cost becomes 2.90. Treating the deposit and loan notionals as one permanently floating balance would miss the reset difference. If the deposit is restricted, even the original economic offset does not establish that its cash can service the debt.