Gap management refers to the process used by business managers to offset the losses caused by debt obligations and interest payments attached to those obligations. Those losses can be larger than expected when prevailing interest rates in the economy rise or fall. As a result, gap management requires that cash inflows are in place which will help to balance out any losses that might be incurred. Ideally, the duration of any borrowings should be roughly the same amount of time as the amount of time on any loans owed to the company, thereby reducing the risk of damage done by interest rate fluctuation.
A large part of the business world is predicated on loans offered from one organization to another. These loans are usually offered in return for eventual repayment along with regular interest payments. Interest payments can have a large effect on a company’s bottom line, especially if prevailing rates change to affect the value of those debts and investments. As a result, financial managers for banks and other institutions issuing debt must be aware of the relationship between assets and liabilities and their changing values, a process known as gap management.
Perhaps the easiest way to think about gap management is to consider the money coming into and going out of a corporation, also known as inflows and outflows. Ideally, more money will be coming in, creating a positive gap. In some cases, more money will be leaving the company to pay off debt obligations than what is coming in from other sources. Whatever the case, this gap must be monitored at all times.
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Many times, the gap occurs because different loans have different durations. For example, a company expecting full repayment on a bond it owns in five years time could be hurting if they have to pay back investors who hold their bonds. In cases like this, gap management entails trying to ensure that the durations of debt obligations are as closely matched up to the durations of any cash inflows as possible.
Keeping track of interest payments on loans is also a big part of the gap management process. When national interest rates fluctuate, it affects the value of debt instruments like bonds. As a result, there is an inherent risk involved with these instruments that must be considered at all times. Balancing out money owed and expected on loans is a good way to protect against interest rates changing and possibly causing financial problems.