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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 holds assets with a market value of USD 1,000 million and a duration of 4.0 years, funded by liabilities of USD 920 million with a duration of 2.5 years. What is the bank's duration gap, using the standard formula DA - (L/A) x DL?

The duration gap is 1.70 years. Liability duration must be scaled by the liabilities-to-assets ratio: 0.92 times 2.5 equals 2.30, and subtracting that from the asset duration of 4.0 gives 1.70 years.

  1. A1.50 years
  2. B1.70 yearsCorrect
  3. C4.00 years
  4. D1.75 years

Explanation

Leverage-adjusted liability duration = 0.92 x 2.5 = 2.30. Duration gap = 4.0 - 2.30 = 1.70 years. Simple difference of durations (1.50) ignores the leverage adjustment.

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