Question

Assuming that the average duration of its $100 million of assets is four years, while the average duration of its $90 million of liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to increase by___________- % (negative if it is a decline) of the total original asset value.

Answer 1

A 5 percentage point increase in interest rates will cause the net worth of First National to increase by $5 million (or 5% of the total original asset value).

Step-by-step explanation:

To calculate the change in net worth of First National, we need to consider the effect of the 5 percentage point increase in interest rates on the duration of its assets and liabilities. Duration measures the sensitivity of the value of a financial instrument or portfolio to changes in interest rates.

Given that the average duration of the assets is four years and the liabilities is three years, we can calculate the change in net worth as follows:

Change in net worth = (Duration of Assets - Duration of Liabilities) * Change in interest rates * Total original asset value

Substituting the given values, we get:

Change in net worth = (4 - 3) * 5% * $100 million = $5 million

Therefore, a 5 percentage point increase in interest rates will cause the net worth of First National to increase by $5 million (or 5% of the total original asset value).