Question

If a bank has a ___________ gap, its net interest margin will be __________ affected by an increase in interest rates

-negative, positive

-negative, adversely

-positive, adversely

-zero positive

the duration of a zero-coupon bond will be _______ the duration of a couple bond with the same yield, maturity and other characteristics.

- lower than

- higher than

-equal to

-more information is needed

Answer 1

positive gap : when the asset position is higher than the liabilities.

negative gap: when the liabilities are higher than the assets.

with the increase in interest rates : the assets will be valued higher and so will the liabilities.

net interest margin is : the net interest earned after paying the interest on liabilties and the interest that is earned on the assets.

so, if the bank has a negative gap, the net interest margin will be adversely affected. as after an increase in interest rates, the liabilities will be valued higher and the assets are lower than the liabilities, although the assets will also be valued higher with the rise in interest rates but due to the fact that the liabilities>assets so the interest paid will be higher , than the interest received as a result the net interst margin will be adversley affected.

so, the correct option is option 2.

duration measures the interest rate risk, that is the sensitivity of the bond to the changes in the interest rates.

the duration of a zero coupon bond is equal to its maturity, the cash flows will be deferred till the bond matures, hence it is most risky and is exposed to the maximum interest rate risk.

wheraeas , the coupon bond, is not exposed to so much risk, as it will receive cash flows in the form of coupons either annually /semi annually and is not much exposed to risk as the zero coupon bonds.so it will start receiving the cash flows sooner than the zero coupn bond.

the correct option is option b, duration of a zero coupon bond is higher than the coupon bond.