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Answer: The sensitivity of assets and liabilities to changes in interest rates is greater when the coupon is lower, the duration is higher, or the overall level of interest rates is lower.
The correct answer is D. The sensitivity of assets and liabilities to changes in interest rates is indeed greater when the coupon is lower, the duration is higher, or the overall level of interest rates is lower. This is because: 1. **Lower Coupon**: Instruments with lower coupons have more of their value tied to the principal repayment rather than interest payments. As a result, changes in interest rates have a more significant impact on their present value. 2. **Higher Duration**: Duration measures the sensitivity of the price of a bond (or any interest-rate-sensitive asset or liability) to a change in interest rates. A higher duration indicates that the instrument is more sensitive to interest rate changes, meaning that its price will change more significantly for a given change in interest rates. 3. **Lower Overall Level of Interest Rates**: When interest rates are already low, there is less room for them to decrease further. Therefore, any change in interest rates, particularly an increase, will have a more pronounced effect on the present value of interest-rate-sensitive instruments. The other options provided are incorrect for the following reasons: A. The statement is incorrect because the percentage change in the value of an asset or liability is not only directly proportional to its duration but also dependent on the corresponding percentage change in interest rates. B. This statement is incorrect because using cash to pay a dividend will decrease the bank's assets, which can affect the overall asset duration of the bank. C. This statement is incorrect because a prepayable mortgage loan typically has a lower duration than an identical non-prepayable loan, making it less sensitive to interest rate changes due to the option for the borrower to refinance at lower rates.
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An American financial institution's finance officer is scrutinizing the company's balance sheet and seeks to understand the potential impact on the institution's equity resulting from changes in interest rates. To assess this, the finance officer has asked a supervisor to perform a duration analysis to evaluate how a 100-basis-point change in interest rates could affect the institution's equity.
A
The percentage change in the value of an asset or liability resulting from a 100-bps change in interest rates is directly proportional to its duration but is unaffected by the corresponding percentage change in interest rates.
B
Using USD 100 million of cash to pay a cash dividend will not affect the overall asset duration of the bank.
C
A prepayable mortgage loan has a higher duration than an identical non-prepayable loan and is typically more sensitive to overall interest rate changes
D
The sensitivity of assets and liabilities to changes in interest rates is greater when the coupon is lower, the duration is higher, or the overall level of interest rates is lower.