Question

how a typical bank-with a positive duration gap and a negative gap-entering into a futures contract to sell a T-bond a specified price can help offset the negative impact of rising interest rate.

Answer 1

Duration Gap Analysis:

Compares the price sensitivity of a bank's total assets with the price sensitivity of its total liabilities to assess the impact of potential changes in interest rate on stockholder's equity. Duration is a measure of the effective maturity of a security. Duration incorporates the timing and size ofa security's cash flows.

Duration measures how price sensitive a security is to changes in interest rates.

Duration GAP Model:

Focuses on either managing the market value of stockholder's equity.

1. The bank can protect either the market value of equity or net interest income, but not both.
2. Duration GAP analysis emphasizes the impact on equity.

Positive and Negative Duration GAPs:

Positive DGAP

• Indicates that assets are more price sensitive than liabilities, on average
• Thus, when interest rates rise (fall), assets will fall proportionately more (less) in value than liabilities.

Negative DGAP

• Indicates that weighted liabilities are more price sensitive than weighted assets
• Thus, when interest rates rise (Fall), assets will fall proportionately less (More) in value that liabilities.