If an FI holds long-term assets funded by short-term liabilities when interest rates rise, the market value of assets will fall by a greater amount than the market value of its liabilities.

Question

Quizplus · Accepted Answer

When interest rates rise, the value of long-term fixed-rate assets decrease more than the value of short-term liabilities. This is because the fixed-rate assets are locked in at a lower interest rate and are now less attractive to investors who can earn a higher return elsewhere. As a result, the FI may experience a decline in net worth or even insolvency if the value of its assets falls below the value of its liabilities.

If an FI Holds Long-Term Assets Funded by Short-Term Liabilities