9-86 What is the interest rate risk exposure of the optimal transaction in the previous question over the next 2 years?
A)The risk that interest rates will rise since the FI must purchase a 2-year CD in one year.
B)The risk that interest rates will rise since the FI must sell a 1-year CD in one year.
C)The risk that interest rates will fall since the FI must sell a 2-year loan in one year.
D)The risk that interest rates will fall since the FI must buy a 1-year loan in one year.
E)There is no interest rate risk exposure.

Question

Quizplus · Accepted Answer

The optimal transaction involves purchasing a 2-year loan and selling a 1-year CD. Therefore, in one year the FI must sell the 1-year CD and re-invest the proceeds in a new 2-year CD. If interest rates have risen in that year, the FI will be forced to reinvest at a lower rate, resulting in a decrease in income. Thus, the FI is exposed to the risk that interest rates will rise, making choice B the correct answer.

9-86 What Is the Interest Rate Risk Exposure of the Optimal