Duration Model

# Duration Model - 15 at maturity • What are the cash flows...

This preview shows pages 1–5. Sign up to view the full content.

Duration Model 1 Advantages of Duration Modeling: Unlike the Maturity Model, the Duration Model considers the following conditions: Maturity distributions (short, intermediate, long). Degree of leverage. Timing of cash flows and TVM. Like the Maturity Model, the Duration Model considers the following condition: Market values.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Understanding Duration 2 1. Understand the concept of duration. 2. Learn how to calculate duration. 3. Understand the economic meaning of the result. 4. Show how the duration measure can be used to immunize the FI against interest rate risk.
A Simple Illustrative on Duration 3 Bank loans client \$100 for one-year at 15%. Client agrees to repay loan in two, equal principal payments of \$50 each, plus accrued interest. Bank finances the loan with a one-year CD, on which it pays

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 15% at maturity. • What are the cash flows? A Simple Illustrative on Duration 4 • At the time of the first payment, six months of interest is due on the full principal amount, plus a principal payment is due: (\$100)(15%/2) = \$7.50 + \$50.00 = \$57.50 • The new principal balance is: \$100.00 - \$50.00 = \$50.00 → Principal on which interest is now based • At the end of the year, the second payment A Simple Illustrative on Duration 5 • The bank has to wait to receive these cash flows. • Based on the time value of money, we can compare the relative value of these two cash flows by discounting them back to today. – The loan rate is 15% (1/2 year is 7.5%). • The PV of the cash flows is: PV = FV/(1 + r ) t 1/2 Year...
View Full Document

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern