Ch.22 Fixed Income II, eoc #23


Why would a flattening of the yield curve cause the liability to increase faster than the asset? Please don’t say because it’s duration is twice as high. I know. But a flattening of the yield curve would indicate that the shorter-term maturities are increasing while the longer-term maturities are decreasing. Right? So, how do you derive the answer from the term structure?

liability is longer term, usually. So if longer term yields are decreasing - the liability would be increasing.

Shorter term assets - yield is increasing - so asset would be decreasing.

Both liabilities + assets are fixed income bonds here.

in mock exams it’ll tell you the duration of assets vs liabilities usually.

OK, thanks. Kind of makes sense to me.

But is the “benchmark” in this question just given to confuse people? This case is an example of liability funding, i.e. the liability is the benchmark and the portfolio duration should match the liability duration of 10.6 (the portfolio’s weighted average duration is 5.1). The “benchmark” (to what) is irrelevant. Or is it not?

the benchmark is the liability. and given that its duration is at least twice as high - for the same interest rate change the liability is MORE sensitive than the Portfolio (Asset).