Vol. 2CFAI pge 446 #A Not sure i understand how durations go up/down. The question states that the company attributes the decline in the duration of its liabilities to increase in interest rates and passage of time. does that relate to the L1 foruma, % price = -duration * % yield how do the liabilities “shrink” in this problem?
without looking at the curriculum I would assume it has to do with the tendency of people to borrow against their life insurance and invest in the higher interest rates. I believe that the term they used was disintermediation. In a sense, it acts as a prepayment and lowers average duration of liabilities. Best, TheChad
yes that makes sense. what about #9 on that page, question A. Why would you reduce target maturity of your assets if your average maturity of loans increased?
Have not read the question but duration can be defined in two ways: - the average maturity. - the sensitivity of value when interest rate change. Since as time passes, the age of the existing liabilities becomes shorter and shorter (assuming no new liabilities) Secondly, as interest rate increases, the value of the bond decreases but flattens toward zero so duration (sensitivity) decreases. Check out the bond price curve in LI where you have a steep curve at low rates then flattens out at higher rates
iregula Wrote: ------------------------------------------------------- > yes that makes sense. > > what about #9 on that page, question A. Why would > you reduce target maturity of your assets if your > average maturity of loans increased? Question 9 addresses another problem. Bank’s securities portfolio acts as a counterweight to the bank’s loan portfolio, so if you don’t want change in the total portfolio (loan and securities), changes in the loan portfolio will necessitate a counterchange in the securities portfolio. In this case, the loan duration gets longer thus duration higher thus more sensitivity toward interest rate --> securities portfolio needs to counterbalance it so the duration of the securities portfolio needs to get lower.
Don’t you need to match durations (long with long)?
Let me give you an example. Say the bank wants to have duration for the total portfolio to be 2. The portfolio consists of a loan portfolio 200M with duration 3 and a securities portfolio 100M with duration = Double check, You have (200*2.5+ 100* 1)/(200+100) = 2 Now the duration of the loan portfolio goes from 2.5 to 3, but the bank wants to maintain overall duration to be 2 (200*3 + 100* x)/(200+100) = 2, solve for x --> x =0. You have x going from 1 down to 0 to compensate for the increase of duration of the loan portfolio.