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Consider the following balance sheet (in millions) for an FI: Assets Liabilities Duration = 10 years $950 Duration...

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Finance

Consider the following balance sheet (in millions) for anFI:

Assets Liabilities

Duration = 10 years $950 Duration = 2 years $860

Equity     90

a)What is the FI's duration gap?

b)What is the FI's interest rate risk exposure?

c)How can the FI use futures and forward contracts to put on amacrohedge?

d) What is the impact on the FI's equity value if the relativechange in interest rates is an increase of 1 percent? That is,DR/(1+R) = 0.01.

e)Suppose that the FI in part (c) macrohedges using Treasurybond futures that are currently priced at 96. What is the impact onthe FI's futures position if the relative change in all interestrates is an increase of 1 percent? That is, DR/(1+R) = 0.01. Assumethat the deliverable Treasury bond has a duration of nineyears.

f)If the FI wants a perfect macrohedge, how many government bondfutures contracts does it need?

g)How does consideration of basis risk change your answers?

Answer & Explanation Solved by verified expert
4.0 Ratings (555 Votes)
a FIs Duration gap duration of assets duration ofliabilitiesliabilities assets 10 2 860950 819 yearsb The FI directly exposed to interest rate increases Themarket value of equity will decrease if interest rateincreasesc The FI can hedge its interest rate risk by selling future    See Answer
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