If a bank has a duration gap of two years,a fall in interest rates from 5% to 8% per annum will lead to a/an:
A) increase of 5.71% in the market value of its net worth.
B) fall of 5.71% in the market value of its net worth.
C) increase of 5.71% in net interest income.
D) fall of 5.71% in net interest income.

Question

Quizplus · Accepted Answer

The duration gap measures the sensitivity of a bank's net worth to changes in interest rates. A positive duration gap implies that the value of assets is more sensitive to changes in interest rates than the value of liabilities. When interest rates fall, the market value of assets increases more than the market value of liabilities, leading to an increase in the bank's net worth. The percentage change in net worth can be approximated by the product of the duration gap and the change in interest rates (in decimal form). Here, a 3% decrease in interest rates (from 5% to 8%) and a duration gap of 2 years would lead to an increase in net worth. The calculation is: 2 * (-3%) = -6%, but since it's an increase in value, it's a positive change. The exact calculation for percentage change might involve more detailed financial formulas, but the basic relationship between duration gap, interest rate changes, and net worth or value change is as described.

If a Bank Has a Duration Gap of Two Years,a