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Explanation:
The statement 'The interest-sensitive gap fails to put into consideration the implications of interest rate fluctuations on the positions of equity' is not a disadvantage of duration-gap management, but rather a limitation of the interest-sensitive gap approach. The duration gap management approach, in contrast, does take into account the effects of interest rate fluctuations on equity positions. This is because duration-gap management involves adjusting the duration of assets and liabilities to match, thereby reducing the sensitivity of the firm's equity to changes in interest rates. Therefore, this choice does not accurately represent a disadvantage of duration-gap management.
Choice A is incorrect. Duration matching, also known as immunization, can indeed be costly and time-consuming. This is because it requires constant rebalancing of the portfolio to maintain the duration match as interest rates change and as assets and liabilities move closer to their maturity dates.
Choice B is incorrect. Immunization is a dynamic problem in that the duration of liabilities and assets changes as they near their maturity. This means that even if a firm has perfectly matched its asset and liability durations at one point in time, it will need to continually adjust its portfolio to maintain this balance due to changes in market conditions or as these instruments approach their maturity dates.
Choice D is incorrect. Duration alone does not accurately measure interest rate risk for significant interest rate changes unless convexity is taken into account. Convexity measures the sensitivity of a bond's price change given a change in interest rates, which becomes more pronounced when there are large swings in rates. Therefore, ignoring convexity could lead to underestimation or overestimation of potential losses or gains from interest rate movements.
Things to Remember
Q.4238 The interest-sensitive gap approach is not enough to fully hedge a financial firm from interest rates risks, thus the need for duration-gap management. The information below identifies some of the disadvantages of duration-gap management, which one is NOT?
A
Duration matching (immunization) can be costly and time-consuming
B
Immunization is a dynamic problem such that the duration of liabilities and assets changes as they near their maturity
C
The interest-sensitive gap fails to put into consideration the implications of interest rate fluctuations on the positions of equity
D
Duration is not accurate for significant interest rate changes unless convexity is taken into account
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