Final answer:
The correct statement is that a financial institution with a positive leverage-adjusted duration gap expects interest rates to rise. This is because it would benefit from the rates increasing due to its assets having a longer duration than its liabilities. Interest rates can fall due to a fall in demand or a rise in supply in the financial markets.
Step-by-step explanation:
The concept in question relates to interest rate risk management in financial institutions, and specifically, the use of a leverage-adjusted duration gap.
A positive leverage-adjusted duration gap indicates that the value of a financial institution's assets is more sensitive to changes in interest rates compared to the value of its liabilities. Conversely, a negative duration gap suggests that the liabilities are more sensitive than the assets.
Statement 2 is correct: A financial institution with a positive leverage-adjusted duration gap expects interest rates to rise. This is because an institution would benefit from increasing rates if its assets (loans) have longer duration than its liabilities (deposits), since it would receive more on its assets before it has to pay out more on its liabilities.
When considering the financial market as a whole, changes that lead to a decline in interest rates include a fall in demand for funds and a rise in supply of funds. Lower demand for loans means that lenders can't charge as high interest rates, and increased supply means there is more competition among lenders, which also drives interest rates down.