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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A bank's investment policy sets a limit that the portfolio's modified duration must not exceed 4.0. The portfolio market value is USD 500 million and its current modified duration is 3.6. Management wants to use the full limit. Approximately how large a change in value would result from a 25 bp parallel rise in yields at the limit duration of 4.0, using the duration approximation?

At the limit duration of 4.0, a 25 bp rise in yields reduces value by about 4.0 x 0.0025 x USD 500 million, which is a USD 5.0 million loss. Using the current duration of 3.6 would understate the exposure permitted by the policy.

  1. AUSD 5.0 million lossCorrect
  2. BUSD 4.5 million loss
  3. CUSD 20 million loss
  4. DUSD 5.0 million gain

Explanation

Change = -D x dy x V = -4.0 x 0.0025 x 500m = -USD 5.0m. Using 3.6 gives USD 4.5m, which is the current-duration answer, not the limit. A rise in yields causes a loss, not a gain, and USD 20m ignores converting bp to decimals properly.

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