If a bank expected interest rates to fall, and if it wanted to profit from the decline, it should increase the duration of its assets and shorten the duration of its liabilities.

Question

Quizplus · Accepted Answer

By increasing the duration of its assets, the bank ensures that its assets will increase in value more than its liabilities if interest rates fall, since longer-duration assets are more sensitive to changes in interest rates. Shortening the duration of its liabilities minimizes the increase in value of what the bank owes, maximizing potential profits from the interest rate decline.

If a Bank Expected Interest Rates to Fall, and If