What Is Mismatch Risk?

Mismatch risk has a number of particular definitions in finance, but with each basically referring to the chance that a loss can arise from an incompatibility between two or more parties and their objectives. Mismatch risk can often take the form of a principal-agent problem.

The principal-agent problem is a conflict in priorities between a person or group and the representative authorized to act on their behalf. An agent may act in a way that is contrary to the best interests of the 澳洲幸运5开奖号码历史查询:principal.

Concrete examples of mismatch risk include:

1. 澳洲幸运5开奖号码历史查询:Swap contract mismatch risk refers to the possibility that a swap dealer will be unable to find a suitable 澳洲幸运5开奖号码历史查询:counterparty for a swap transaction for which it is acting as an intermediary.
2. For investors, mismatch risk occurs when an investor chooses investments that are not suitable for their circumstance, risk tolerance, or means.
3. For companies, mismatch risk arises when assets generating cash to cover liabilities do not have the same interest rates, maturity dates, and/or currencies.

Understanding Mismatch Risk

Investors or companies expe❀rience mismatch risk when transactions in which they engage or assets they hꦏold are not aligned with their needs.

As discussed above, there are three common types of mismatch risk related to sw♔ap transactions, investor investments, and cash fꦏlows.

Mismatch Risk with Swaps

For swaps, a number of factors can make it difficult for a 澳洲幸运5开奖号码历史查询:swap bank or another intermediary to find a counterparty for a swap transaction. For example, one company may need to engage in a swap with a very large notional principal but finds it difficult to find a willing counterparty to take t🧔he other side of the transaction. The number of potential swappers may be limited, in this case.

Another example may be a swap with very specific terms. Again, counterparties may not have needs for those exact terms. In order to gain some of the benefits of the swap, the first company may have to accept slightly altered terms. That could leave it with an imperfect hedge or a strategy that may not match its specific for🧜ecasts.

Mismatch Risk for Investors

For investors, a mismatch between investment type and investment horizon can be a source of mismatch risk. For example, mismatch risk would exis🥃t in a situation where an investor with a short investment horizon (such as one who is near retirement) invests heavily in speculative biotech stocks. Typically, investors with short investment horizons should focus on less speculative investments such as fixed income securities and blue-chip equities.

Another example would be an investor in a low tax bracket investing in tax-free 澳洲幸运5开奖号码历史查询:municipal bonds. Or a risk-averse investor that buys an 澳洲幸运5开奖号码历史查询:aggressive m🧸utual fund or🙈 investments with significant volatility.

Mismatch Risk for Cash Flows

For companies, a mismatch between assets and liabilities may produce cash flow that does not match with liabilities. One example might be when an asset generates semi-annual payments, but the company must pay rent, utilities, and suppliers on a monthly basis. The company may be exposed to missing its payment obligations if it doesn't manage its money tightly between receiving funds.

Another example might be a company receiving income in one currency but having to pay its obligations in another currency. 澳洲幸运5开奖号码历史查询:Currency swaps might be employed to mitigate that risk.

A Classic Mismatch Example

The classic example of risks between assets and liabilities is a bank that borrows in the short-term market to lend in the long-term market. When short-term interest rates rise and long-term rates stay flat, the bank's ability to profit declines. The spread between short- and long-term rates, or the 澳洲幸运5开奖号码历史查询:yield curve, shrinks and that squeezes the bank's 澳洲幸运5开奖号码历史查询:profit margins.

Compound that risk for a global bank with currency mis𝕴matches and the need for an exotic, hard to accomplish, swap transaction to mitigate those risks, and the bank has a triple mismatch. For example, assume a bank has $1 billion in short-term borrowings in USD, and $1 billion long-term loans overseas in dif𝓰ferent currencies. While they may have other borrowings and loans that help hedge the currency exposure, they may still be exposed to currency fluctuations which affect their profitability.

They could enter into a swap contr🍸act to help offset some of the currency fluctuations. This once again may leave them with a possible mismatch risk related to the swap transactions.