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XYZ Bank has DA = 2.4 years and DL = 0.9 years. The bank has total equity of $82 million and total assets of $850 million. Currently, interest rates are at 6%.
-To set the bank's duration gap to zero the bank could

Question

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XYZ Bank has DA = 2.4 years and DL = 0.9 years. The bank has total equity of $82 million and total assets of $850 million. Currently, interest rates are at 6%.
-To set the bank's duration gap to zero the bank could

Quizplus · Accepted Answer

To set the bank's duration gap to zero, the bank needs to adjust its assets' duration (DA) or its liabilities' duration (DL) so that the weighted average duration of its assets equals the weighted average duration of its liabilities. The duration gap (DG) is calculated as DG = DA - (DL * (A/E)), where A is the total assets, E is the total equity, and A/E is the leverage ratio. Given the bank's DA = 2.4 years, DL = 0.9 years, total equity of $82 million, and total assets of $850 million, setting DG to zero requires adjusting DL. Option B, increasing DL to 2.656 years, is the correct choice because it is the only option that directly addresses adjusting the duration of liabilities to match the adjusted duration of assets, considering the bank's leverage.

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