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FRM Part II · FRM Exam Part II · Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques

A bank has assets of $800 million with duration 3.5 years and liabilities of $720 million with duration 3.0 years. Which statement about its interest rate exposure is correct?

The leverage-adjusted duration gap is 0.8 years, which is positive, so the economic value of equity falls when rates rise. Assets are larger and longer in duration than the leverage-weighted liabilities, so they lose more value than the liabilities. Similar raw durations do not give immunization.

  1. AThe leverage-adjusted duration gap is positive, so EVE falls when rates riseCorrect
  2. BThe duration gap is negative because liability duration is lower than asset duration
  3. CThe bank is immunized because asset and liability durations are close
  4. DThe leverage-adjusted duration gap is positive, so EVE rises when rates rise

Explanation

Gap = 3.5 - (720/800)×3.0 = 3.5 - 2.7 = 0.8 years, positive. Positive gap means assets lose more value than liabilities when rates rise, so EVE falls. Equal-looking durations do not immunize because liabilities are smaller than assets.

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