The correct answer cannot be a parallel upward shift; the value of the assets would decline by about 6.2 times the shift while the value of the liabilities would decline by about 10.2 times the shift; that’s a good thing.
To decide between a flattening or steepening yield curve it would be helpful to know the average maturity of the assets and liabilities. As we don’t know those numbers, we have to make the reasonable assumption that the average marturity of the liabilities is greater than the average maturity of the assets (to account for the duration difference). Given that, flattening is bad - the shorter-maturity assets will drop in value while the longer-maturity liabilities would increase in value - and steepening is good - the shorter-maturity assets will increase in value while the longer-maturity liabilities will decrease in value.
So they should be concerned about a flattening of the yield curve.
Not necessarily: if the liabilities are zero-coupon and the assets pay coupons (or worse: are amortizing securities), the duration of the assets will be shorter than those of the liabilities even with the same (or longer) average maturity.
The shorter maturity assets will increase in value while the longer maturity liabilities will decrease in value: This is a good thing for investor right (as liabilities decrease) ? Why would he be concerned?
Question asked is which one should he be concerned about . Not why should he be concerned .
Obviously the 3 scenarios are distinctly different.
And only flattening is worrying to him since the assets rise / decline/whatever by a small amount ( given smaller duration ) while the liabilities RISE by a large amount . Only way for flattening to happen from a initial upward sloping curve is when the long declines appreciably ,example circa spring 2010 , which makes tghe liability look horrible
That _ isn’t _ the only way flattening could happen; it’s one way flattening could happen. Another way is for the short end of the yield curve to rise while the long end remains unchanged. Or the short end could rise a lot while the long end rises a little. Or the long end could decline a little while the short end rises a little, or a lot.
There are many ways that the yield curve can flatten. And all of them are bad.
The problem is that the language of yield curve changes only makes sense for upward-sloping yield curves. The term “steepening” means that the difference (long-end yield – short-end yield) increases, and the term “flattening” means that the difference (long-end yield – short-end yield) decreases. Think of “steepening” as “long end moves up relative to the short end” or “short end moves down relative to the long end”; think of “flattening” as “long end moves down relative to the short end” or “short end moves up relative to the long end”.
If the yield curve is inverted, then “steepening” will actually make it look flatter, and “flattening” will make it look steeper (down). That’s unfortunate, but it’s the language we’ve been given, so we have to work with it.
As Victor Borge used to say, “I can’t stand sitting. (It’s _ your _ language; I’m just trying to use it.)”
In regards to this - assuming that a flattening of the yield curve involved short term rates coming down and the subsequent rise in asset and liability values (inverse relationship between yield and values) longer duration liability values would rise by more than shorter duration asset values due to increased interest rate sensitivity… Correct?