Question

5. The following information is provided for Green Tree Bank Cash Deposit N (2 years, 2%) Loan M (4%, 4 years) 250 Equity TOTAL Assets 325 TOTAL Liabilities 300 325 5a. Estimate the durations of Loan M and Deposit N. (8 Points) Period -Nm 5b. Using the duration formula estimate the change in the value of the equity if interest rates are expected to decrease by 1%. (8 Points) ***ONLY CHOOSE ONE QUESTION 5C or 5D TO ANSWER. (5 Points) 5c. Define Duration and explain why it is a better measure of Interest Rate Risk than the GAP Repricing Model or the Maturity Model 5d. Describe three properties or features of Duration. OR List and Describe three difficulties in applying the Duration Model.

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say Duration a Mloon perino can How $10 prat prg lot un cof 0.9615 9.615 o.g2us 19.2u5 O. 88 89 sf. 889 prx Perio 9615 $18.ug $26.667 910 $10 & 2.60 0.85 ug 222 224 $88901 $250.023 $943.87 Duration = s9u3.87 3.77 years $ 250.023 - Duration of Deposit N Period casn thou Prat 91 at 2. 6.9803 $6 pr of prx CF Perod $5.882 35.882 294099 1588194 9306 O. 96 11 $ 300 $594.076 Duration: 3594.076 $300 - 1.98 years so & change in the pricey Moon (Duration change in yield) (3.77 & 0.01) = 0.0377 Expected poru = $250 C1-0.037) - $240 95 11 change in the priu q Deposit & C 1098 +0.01) - 0.0198 Expected pru $300 (-0.0198) & 29400 66

5d)

Duration of a coupon paying bond is always less than its maturity. For a non-coupon paying bond, the duration is the same as its maturity. Bonds with longer maturities have longer durations. This is because the coupon payments will be spread over longer periods and will be more affected by inflation. The bond with higher coupon rates have lower duration, and vice versa. When the coupon rate is lower than the yield, the duration first increases with maturity to some maximum value then decreases to the asymptotic limit value. As the time to maturity increases to infinity, the duration does not increase to infinity but tends to a finite limit independent of the coupon rate.