Transcription of appendix 1 to c9hapter Duration Gap Analysis - …
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appendix 1 to c9hapter Duration Gap Analysis - …
32An alternative method for measuring interest-rate risk, called Duration gap Analysis ,examines the sensitivity of the market value of the financial institution s net worth tochanges in interest rates. Duration Analysis is based on Macaulay s concept of Duration ,which measures the average lifetime of a security s stream of payments (described inthe appendix to Chapter 4). Recall that Duration is a useful concept, because it pro-vides a good approximation, particularly when interest-rate changes are small, of thesensitivity of a security s market value to a change in its interest rate using the fol-lowing formula:(1)where% P (Pt 1 Pt)/Pt percent change in market value of the securityDUR durationi interest rateAfter having determined the Duration of all assets and liabilities on the bank s bal-ance sheet, the bank manager could use this formula to calculate how the marketvalue of each asset and liability changes when there is a change in interest rates andthen calculate the effect on net worth.
32 An alternative method for measuring interest-rate risk, called duration gap analysis, examines the sensitivity of the market value of the financial institution’s net worth to
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