A financial institution can hedge its interest rate risk by:
A) matching the duration of its assets to the duration of its liabilities.
B) setting the duration of its assets equal to half that of the duration of its liabilities.
C) matching the duration of its assets, weighted by the market value of its assets with the duration of its liabilities, weighted by the market value of its liabilities.
D) setting the duration of its assets, weighted by the market value of its assets to one half that of the duration of the liabilities, weighted by the market value of the liabilities.

Question

Quizplus · Accepted Answer

Matching the duration of assets with the duration of liabilities is a common strategy employed by financial institutions to hedge their interest rate risk. However, simply matching the duration may not be enough as the market values of assets and liabilities may not be equal. Therefore, weighing the duration by the market value of assets and liabilities is a more effective method. Option C fits this criterion, as it suggests matching the duration of assets weighted by the market value of assets with the duration of liabilities weighted by the market value of liabilities. Options A and B do not take into account market value weighting, while option D suggests a weighting of only one-half, which may not be reflective of the actual market value ratio of assets to liabilities.

A Financial Institution Can Hedge Its Interest Rate Risk By