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

A risk manager notes that a bank's duration gap is zero. Which limitation of using duration gap alone to measure EVE risk remains valid?

A zero duration gap still leaves exposure to non-parallel yield curve shifts and convexity differences between assets and liabilities. Duration only captures first-order sensitivity to small parallel moves, so twists, large shocks and embedded options can still change the economic value of equity.

  1. AThe bank can still lose value from non-parallel yield curve shifts and convexity effectsCorrect
  2. BThe bank is fully protected against all interest rate movements
  3. CEVE is unaffected by rate changes because equity has no duration
  4. DZero gap means net interest income is also unchanged over all horizons

Explanation

Duration is a first-order, parallel-shift measure. With a zero gap, twists in the curve, differing convexity, and embedded options such as prepayments can still change EVE. It also does not guarantee stable net interest income, which is an earnings measure.

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