Banks and other financial institutions can best manage interest rate risk by ________.

Question

Quizplus · Accepted Answer

Matching the durations of assets and liabilities is the best way to manage interest rate risk. This means that the maturity of assets and liabilities should be matched, ensuring that the cash flows from both sides are received or paid out at the same time. This will reduce the potential impact of changes in interest rates on the net income of the institution. Maximizing the duration of assets and minimizing the duration of liabilities (option A) or minimizing the duration of assets and maximizing the duration of liabilities (option B) do not ensure that the cash flows from both sides are matched, which can lead to interest rate risk. Matching the maturities of their assets and liabilities (option D) is a close alternative but matching duration is more appropriate as it considers the timing of cash flows, while maturity only considers the end date of the asset/liability.

Banks and Other Financial Institutions Can Best Manage Interest Rate