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Question 6 A bank has an average asset duration of 4 years and an average liability...

Question 6

A bank has an average asset duration of 4 years and an average liability duration of 1.5 years. This bank has total assets of $500 million and total liabilities of $450 million. Currently, market interest rates are 10 percent. If interest rates rise by 1 percent (to 11 percent), what is this bank's change in net worth?

	A.	Net worth will decrease by $12.05 million
	B.	Net worth will decrease by $15.45 million
	C.	Either the net worth will not change at all, or none of the other responses are correct.
	D.	Net worth will increase by $15.45 million
	E.	Net worth will increase by $12.05 million

Expert Solution

A. Net worth will decrease by $12.05 million

Provided,

Total Assets = $500 million

Total Liabilities = $450 million

thus,

Duration is the measure of price sensitivity of Assets or debt with change in interest rate. We can calculate the new price of Assets/Debt using duration and change in interest rate.

where,

P1 = New value of Assets/Debt

i = interest rate

D = Duration

Provided,

Current Interest rate (i) = 10%

Change in Interest rate = +1%

Duration of Assets = 4

Duration of Liabilities = 1.5

jeff jeffy answered 3 months ago

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