For a bank that has a negative duration gap, an increase in interest rates will cause a(n) _______ in the economic value of assets, a(n) _______ in the economic value of liabilities, and a(n) _______ in the economic value of equity.
A)increase, decrease, increase
B)increase, increase, decrease
C)increase, increase, increase
D)decrease, decrease, increase
E)decrease, increase, decrease

Question

Quizplus · Accepted Answer

A negative duration gap means that liabilities have a longer duration than assets. This implies that if interest rates increase, the cost of liabilities would increase more than the income from assets.

Therefore, an increase in interest rates will result in a decrease in the economic value of assets (as their price will fall), a decrease in the economic value of liabilities (as their cost of interest rates will increase), and an increase in the economic value of equity (as the reduction in liabilities will outweigh the decrease in assets).

For a Bank That Has a Negative Duration Gap, an Increase