A bank has an average duration of its liabilities equal to 2 years. The bank's average duration of its assets is 3.5 years. The bank's market value of equity is at risk if ________.
A) interest rates fall
B) credit spreads fall
C) interest rates rise
D) the price of all fixed-income securities rises

Question

Quizplus · Accepted Answer

The bank's market value of equity is at risk if interest rates rise. This is because as interest rates rise, the value of the bank's assets (which have a duration of 3.5 years) will decrease more than the value of its liabilities (which have a duration of 2 years). This creates an asset-liability duration mismatch that may result in losses for the bank and a decline in the market value of its equity.

A Bank Has an Average Duration of Its Liabilities Equal