An FI is having a positive duration gap. What is the FI's interest rate risk exposure...

An FI is having a positive duration gap. What is the FI's interest rate risk exposure and how can it use financial futures to hedge that risk exposure?
1. The FI can hedge its exposure to interest rate decreases by selling future contracts
2. The FI can hedge its exposure to interest rate decreases by buying future contracts
3. The FI can hedge its exposure to interest rate increases by buying future contracts
4. The FI can hedge its exposure to interest rate increases by selling future contracts

Solutions

Expert Solution

In this case the duration gap is positive which mean duration of assets is more than duration of liabilities. FI is therefore exposed to risk of increase in interest rate. The increase in interest rate would cause the decrease in value of assets as assets duration is higher. In order to hedge this risk FI should sell future contract.

Thus, FI can hedge its exposure to interest rate increase by selling future contract.

jeff jeffy answered 2 years ago

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