FinancialInstitution XY has assets of £1 million invested in a 30-year, 10 percentsemiannual coupon Treasury bond selling at par. The duration of this bond hasbeen estimated at 9.94 years. The assets are financed with equity and a£900,000, 2-year, 7.25 percent semiannual coupon capital note selling at par.
a.What is the leverage-adjusted durationgap of Financial Institution XY?
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b.What is the impact on equity value if therelative change in all market interest rates is a decrease of 20 basis points?Note, the relative change in interest rates is DR/(1+R/2) = -0.0020.
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c.Using the information calculated in parts(a) and (b), what can be said about the desired duration gap for a financialinstitution if interest rates are expected to increase or decrease.
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d.Verify your answer to part (c) bycalculating the change in the market value of equity assuming that the relativechange in all market interest rates is an increase of 30 basis points.
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e.What would the duration of the assetsneed to be to immunize the equity from changes in market interest rates?