Exam 6: Interest Rate Risk Measurement: the Duration Model

The effect of interest rate changes on the market value of an FI's net worth breaks down into three effects, these being the leverage adjusted duration gap, the:

Duration is a less accurate predictor for the change in an FI's net worth in case of large interest rate shocks because it assumes a:

Which of the following statements most appropriately responds to the critique that duration matching is costly and time consuming?

The statement that a portfolio is immunised using duration matching:

Which of the following statements is true?

One method of changing the positive leverage adjusted duration gap for the purpose of immunising the net worth of a typical depository institution is to increase the duration of the assets and to decrease the duration of the liabilities.

Using the leverage adjusted duration gap, it is possible to measure the effect of changing interest rates on an FI's net worth.

Proof the following three propositions using a simple numerical example for each of the cases. a. The duration of an asset or liability with intervening cash flows between issue and maturity is smaller than its maturity. b. The duration of an asset or liability without any intervening cash flows between issue and maturity equals its maturity. c. Despite the fact that perpetuities such as consol bonds have no maturity, it is possible to calculate their duration.

Duration measures changes in an FI's net worth inaccurately if interest rate changes are large.

As interest rates increase (decrease) the value of an asset or a liability decreases (increases).

As interest rates increase the price of an asset or liability:

Consider a security with a face value of $100 000, which is to be repaid at maturity. The security pays an annual coupon of 8 per cent and has a maturity of three years. The current discount rate is 10 per cent. What is the security's duration (round to two decimals)?

Duration matching is a desirable interest rate risk management tool as it captures changes in interest rates over long periods of time.

Duration is a direct measure of the interest rate sensitivity of an asset or liability, which means that:

The duration of a zero-coupon bond is always smaller than its maturity.

The special feature of consol bonds is that:

How can a negative duration gap of 0.21 years be interpreted?

The bank has a negative maturity gap. Is the bank exposed to interest rate increases or decreases and why?

Assume that the required yield to maturity on a consol bond increases from 6 per cent to 12 per cent. What is the impact on the consol bond's duration?

Consider an asset with a current market value of $250 000 and a duration of 3.3 years. Assume the asset is partially funded through zero-coupon bonds which currently sells for $225 000 and has a maturity of 4 years. The current discount rate is 15 per cent. Which of the following statements is true?