1. Asset&Liability Management
The Concept of Duration and
Managing A Bank’s Duration Gap

2. The Concept of Duration
7-2
The Concept of Duration
Duration is the weighted average maturity of a promised stream of future cash flows.

3. 7-3
To Calculate Duration

4. Price Sensitivity of a Security
7-4
Price Sensitivity of a Security

5. Duration of an Asset Portfolio
7-5
Duration of an Asset Portfolio
Where:
wi = the dollar amount of the ith asset divided by total assets
Dai = the duration of the ith asset in the portfolio

6. Duration of a Liability Portfolio
7-6
Duration of a Liability Portfolio
Where:
wi = the dollar amount of the ith liability divided by total liabilities
Dli = the duration of the ith liability in the portfolio

7. 7-7
Duration Gap

8. Change in the Value of a Bank’s Net Worth
7-8
Change in the Value of a Bank’s Net Worth

9. Impact of Changing Interest Rates on Bank’s Net Worth
7-9
Impact of Changing Interest Rates on Bank’s Net Worth

10. Limitations of Duration Gap Management
7-10
Limitations of Duration Gap Management
Finding Assets and Liabilities of the Same Duration Can be Difficult
Some Assets and Liabilities May Have Patterns of CFs Not Well Defined
Customer Prepayments May Distort the Expected Cash Flows in Duration
Not a Linear Relationship Between Prices and Interest Rates