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

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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.
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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.
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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
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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...
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