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Exam 9: Interest Rate Risk II

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Question 1

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Duration measures the average life of a financial asset.

A) True
B) False

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Question 2

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The following is an FI's balance sheet ($millions) . Notes to Balance Sheet: Munis are 2-year 6 percent annual coupon municipal notes selling at par. Loans are floating rates, repriced quarterly. Spot discount yields for 91-day Treasury bills are 3.75 percent. GICs are 1-year pure discount certificates of deposit paying 4.75 percent. What is this bank's interest rate risk exposure, if any?

A) The bank is exposed to decreasing interest rates because it has a negative duration gap of -0.21 years.
B) The bank is exposed to increasing interest rates because it has a negative duration gap of -0.21 years.
C) The bank is exposed to increasing interest rates because it has a positive duration gap of +0.21 years.
D) The bank is exposed to decreasing interest rates because it has a positive duration gap of +0.21 years.
E) The bank is not exposed to interest rate changes since it is running a matched book.

F) A) and B)
G) B) and E)

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C

Question 3

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Consider a six-year maturity, $100,000 face value bond that pays a 5 percent fixed coupon annually. What is the percentage price change for the bond if interest rates decline 50 basis points from the original 5 percent?

The leverage adjusted duration of a typical depository institution is positive.

Buying a fixed-rate asset whose duration is exactly equal to the desired investment horizon immunizes against interest rate risk.

Third Duration Investments has the following assets and liabilities on its balance sheet. The two-year Treasury notes are zero coupon assets. Interest payments on all other assets and liabilities occur at maturity. Assume 360 days in a year. What is the leverage-adjusted duration gap?

Matching the maturities of assets and liabilities is not a perfect method of immunizing the balance sheet because the timing of the cash flows is likely to differ between the assets and liabilities.

Investing in a zero-coupon asset with a maturity equal to the desired investment horizon removes interest rate risk from the investment management process.

Which of the following statements is true?

For a given change in required yields, short-duration securities suffer a smaller capital loss or receive a smaller capital gain than do long-duration securities.

The following information is about current spot rates for Second Duration Savings' assets (loans) and liabilities (CDs) . All interest rates are fixed and paid annually. What is the interest rate risk exposure of the optimal transaction in the previous question over the next 2 years?

Duration of a fixed-rate coupon bond will always be greater than one-half of the maturity.

The duration of a portfolio of assets can be found by calculating the book value weighted average of the durations of the individual assets.

All fixed-income assets exhibit convexity in their price-yield relationships.

The cost in terms of both time and money to restructure the balance sheet of large and complex FIs has decreased over time.

The value for duration describes the percentage increase in the price of an asset for a given increase in the required yield or interest rate.

A $1,000 six-year Eurobond has an 8 percent coupon, is selling at par, and contracts to make annual payments of interest. The duration of this bond is 4.99 years. What will be the new price using the duration model if interest rates increase to 8.5 percent?

Convexity is a desirable effect to a portfolio manager because it is easy to measure and price.

Immunizing net worth from interest rate risk using duration matching requires that the duration match must be realigned periodically as the maturity horizon approaches.

An FI purchases at par value a $100,000 Treasury bond paying 10 percent interest with a 7.5 year duration. If interest rates rise by 4 percent, calculate the bond's new value. Recall that Treasury bonds pay interest semiannually. Use the duration valuation equation.