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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's assets have a duration of 4.0 years and liabilities have a duration of 4.0 years, with assets of 1,000 and liabilities of 900. The treasurer says the bank is immunized against rate changes because the durations match. The best critique is that:

Matching durations does not immunize equity because the leverage-adjusted duration gap is 4.0 minus 0.9 times 4.0, or 0.4 years. The bank still has a positive gap, so its equity value falls when rates rise.

  1. ADuration matching is irrelevant when assets exceed liabilities
  2. BMatching durations ignores the leverage-adjusted duration gap, so equity value remains exposed to rate changesCorrect
  3. CImmunization requires that the asset duration be zero
  4. DDuration matching only works for liabilities with floating rates

Explanation

The equity change depends on D_A - (L/A)D_L = 4.0 - 0.9*4.0 = 0.4 years, times assets. So equity value still falls when rates rise. Matching raw durations ignores leverage.

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