Question

Assume that the First National Bank initially has the balance sheet shown above and the interest rates are initially at 10%.

the duration gap is 1.72, what will happen to the bank’s net worth if interest rates rise by 10%?

Will the bank stay in business? Why or why not? Explain your answers and show all the calculations.

Answer 1

The bank’s net worth will decrease if interest rates rise by 10% because the duration gap is positive.

So, the bank will not stay in business. A positive duration gap is when the duration of assets exceeds the duration of liabilities (which means greater exposure to rising interest rates). If rates go up by 10% the price of assets fall more than the price of liabilities. To find the exact change in net worth, we need to know the date for assets and liabilities.