Explore BrainMass
Share

Uses of Maturity Gap and Duration Gap

This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

a. Explain how portfolio managers can use maturity gap and duration gap to measure their exposure to interest-rate risk.

b. Explain how portfolio managers can use financial options and futures to hedge interest-rate risk.

c. Describe how portfolio managers use financial swaps to control their risk exposure. Explain how both parties in an agreement can benefit from a swap.

© BrainMass Inc. brainmass.com March 22, 2019, 2:41 am ad1c9bdddf
https://brainmass.com/economics/finance/maturity-gap-duration-gap-585642

Solution Preview

See the attached file.
a. Explain how portfolio managers can use maturity gap and duration gap to measure their exposure to interest-rate risk.
Maturity Gap focuses on equity value changes and ignores cash flow timing. Portfolio managers measure the difference between a firm's weighted average asset maturity (MA) and weighted average liability maturity (ML).
Maturity Gap = (MA - ML)
MA = WA1MA1 + WA2MA2 + WA3MA3 + ... + WAnMAn
ML = WL1ML1 + WL2ML2 + WL3ML3 + ... + WLnMLn
WAi = (market value of asset i)/(market value of total assets).
WLi = (market value of liability j)/(market value of total liabilities)
MAi is the maturity of asset i.
MLi is the maturity of liability j.
Here
• When (MA - ML) > 0 then an increase (decrease) in interest rates is expected to decrease (increase) a financial firm's equity.
• When (MA - ML) < 0 then an increase (decrease) in interest rates is expected to increase (decrease) a financial firm's equity.
Equity = Assets - Liabilities
or in change form,
Δ Equity = Δ Assets - ΔLiabilities
Equity, Assets and Liabilities are measured in market value.

On the other hand Duration Gap -focuses on equity value including cash flow timing and is considered as the most complete and accurate measure of ...

Solution Summary

This solution discusses the uses of maturity gap and duration gap to measure the exposure to interest-rate risk, hedging, and use of financial swaps.

$2.19