Question3 Which of the following statements is FALSE? Select one alternative: a. For a typical depository institution, interest rate risk can be minimised if duration of assets is always maintained above the leverage adjusted duration of the liabilities. b. Immunisation requires portfolio rebalancing when interest rates move. c. Measurement of an FI's interest rate risk is rendered inaccurate due to the presence of off-balance sheet assets and liabilities. d. Duration model estimates the change in market value of an FI when interest rate changes. e. A manager should consider the cost of restructuring the balance sheet before deciding to immunise the interest rate risk sensitivity gap of the FI. ResetMaximum marks: 2 Flag question undefined

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BlackTom AI · Accepted Answer

First, let's restate the question and the answer choices to frame what we are evaluating.
Question: Which of the following statements is FALSE? Options:
 a) For a typical depository institution, interest rate risk can be minimised if duration of assets is always maintained above the leverage adjusted duration of the liabilities.
 b) Immunisation requires portfolio rebalancing when interest rates move.
 c) Measurement of an FI's interest rate risk is rendered inaccurate due to the presence of off-balance sheet assets and liabilities.
 d) Duration model estimates the change in market value of an FI when interest rate changes.
 e) A manager should consider the cost of restructuring the balance sheet before deciding to immunise the interest rate risk sensitivity gap of the FI.

Now, we examine each statement in turn to determine whether it is true or false, noting the underlying concepts of interest rate risk management in financial institutions.

Option a: The claim is that risk minimisation occurs by always keeping the asset duration above the leverage-adjusted duration of liabilities. In classic immunisation theory, immunisation is achieved when the portfolio’s duration matches the target horizon and the asset-liability mix is structured so that small interest rate changes have minimal impact on the net present value at the horizon; however, stating that risk is minimised simply by maintaining asset duration above a leverage-adjusted liability duration is an oversimplification. In practice, it is not guaranteed to minimise risk under all rate scenarios, and mismatches or other risk sources (convexity, funding needs, optionality) can still affect outcomes. Therefore, this proposition is generally considered false or at best incomplete as a blanket rule.

Option b: Immunisation often involves rebalancing the portfolio when interest rates move in order to restore the duration-matching condition or to maintain die-hard hedging properties over a specified horizon. The concept of dynamic immunisation commonly entails periodic rebalancing as rates shift, so this statement is aligned with standard practice. This appears to be a true characterization.

Option c: It is sometimes claimed that measuring interest rate risk can be distorted or rendered inaccurate due to the presence of off-balance sheet (OBS) assets and liabilities, because such items can introduce contingent exposures, credit lines, guarantees, and other features not captured in the on-balance-sheet duration analysis. In advanced risk assessment, OBS activities are indeed additional sources of risk that complicate measurement, so this statement has validity as a cautionary note. This can be considered true in many contexts.

Option d: The duration model is specifically used to estimate how the market value of an institution’s instruments will change as interest rates move, by approximating vega-like sensitivity through duration. This is a standard description of what a duration model does, so this statement is true.

Option e: When considering immunisation, a manager should weigh the cost of adjusting the balance sheet (such as restructuring funding, issuing or retiring debt, and other balance-sheet changes) before pursuing immunisation of the gap. Since capital and funding costs affect the net benefit of immunisation, this statement reflects a prudent, real-world consideration and is true.

Putting these evaluations together, the false statement among the options is Option a, because the blanket assertion that interest rate risk can be minimised simply by maintaining asset duration above the leverage-adjusted duration of liabilities ignores the nuances of immunisation, convexity, horizon considerations, and other risk factors. The other statements (b, c, d, e) align more closely with accepted concepts in interest rate risk management and immunisation theory, though each has its own caveats in practical application.

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