agers assessment of where rates will be three months from now!), the price the bank must pay for reducing uncertainty, which is the lower spread return. Alternatively, the bank could lend in the 6-month period, funding initially for three months, and buying an interest-rate cap with a ceiling rate of 6.60% and pegged to Libor, the rate at which the bank can actually fund its book.   Although simplistic, these scenarios serve to illustrate what is possi- ble, and indeed there are many other strategies that could be adopted. The approaches described in the last option show how derivative instru- ments can be actively used to manage the banking book, and the cost that is associated with employing them.   The Balance Sheet ALM and transactions required in managing the banks traditional activ- ity may first be viewed in the context of the balance sheet. A banking bal- ance sheet essentially is a grouping of the following activities:     ■ treasury and banking transactions ■ collection of deposits and disbursing loans ■ financial assets ■ long-dated assets, and capital (equity and long-term debt)   A simplified balance sheet is shown in Exhibit 13.2. The Financial Accounting Standards Board has defined assets as "probable future economic benefits obtained or controlled" by the bank that have arisen as a result of transactions entered into by the bank. Lia- bilities are defined as "probable future sacrifices of economic benefits arising from present obligations" of the bank to transfer assets to other bodies as a result of transactions it has entered into. Assets are further sub-divided into current assets which are cash or can be converted into cash within one year, and long-term assets which are expected to provide benefits over periods longer than one year. A similar classification is applied to current liabilities and long-term liabilities. The relative shares of each constituent in a bank balance sheet will depend on the type of activity carried out by the bank. Commercial banks have a higher share of deposit-taking and loan activity, which are held in the banking book. Integrated banking groups combining com- mercial activity and investment activity, and investment banks, will have a greater proportion of market transactions in the capital markets, such as bond trading, equity trading, foreign-exchange, and derivatives mar- ket making. These activities will be placed in the trading book. Risk management in a bank is concerned (among other things) with the fund-