Asset Liability Gap

[notjusttp]

Hi David,

I need your assistance in the following question

Q)
If interest rates rise, a bank with a positive maturity gap will experience:
Choose one answer.
a. Either a gain or a loss of equity capital.
b. A loss of equity capital.
c. A gain in equity capital.
d. No change in equity capital.

The correct answer is A loss of equity capital.

If the maturity gap is positive, the assets have a longer weighted average maturity than the liabilities. If rates rise, the value of the liabilities will fall by less than the value of the assets, and equity capital will decrease.

MY DOUBT

1) What exactly is the concept of maturity gap and in which presentation of BT is it covered?
2) I did not get this concept that as rates rise why value of liabilities will fall by less that value of assets?

Thanks and best regards
Amit

 

[David Harper CFA FRM]

Hi Amit,

1) it's not in BT presentation b/c it isn't assigned; this would not be a good question vis-a-vis 2009 assigments (this refers to an older approach)

2) more likely, it would appear in terms of duration: all other things being equal, longer maturity (term to maturity) implies longer duration. But an FRM candidate should know why maturity does not correspond with duration? Why doesn't maturity correspond exactly with duration? So, say (e.g.)

assets average duration = 10 (i.e., average maturity > 10)
liabilities average duration = 5 (i.e., average maturity > 5)

if rates increase by +1%

then change in asset value ~ (approx only!) = -10 * 1% = -10%
change in liabilities value ~ = -5 * 1% = -5%

equity = assets - liabilities, so
change in equity = -10% - (-5%) = -5%

hope that helps, David

 

[notjusttp]

Hi David,

Thanks for this so it means positive mat gap means assets have a higher mat period than liab and hence higher duration..Tks for this..Amit