The greater interest rate sensitivity of the long-term asset will cause a reduction in the value of that asset which is lesser than the corresponding increase in the value of the short-term liability.

Question

Options

• ATrue
• BFalse

• A
  80% (36)
• B
  20% (9)

Explanation

Option A is True because this statement accurately captures the asymmetric balance sheet impact of a duration mismatch between long-term assets and short-term liabilities. Although long-term assets carry higher interest rate sensitivity (greater duration), the reduction in their market value from an adverse rate move is outpaced by the corresponding increase in the short-term liability's value - because short-term liabilities reprice frequently at rising market rates, compounding the interest burden in a way that exceeds the one-time mark-to-market decline on the asset side. This is the core danger of a positive duration gap: the liability side's repricing effect can overwhelm the asset side's capital loss. Option B (False) would incorrectly imply the long-term asset's greater sensitivity always produces the larger absolute dollar impact, which ignores how frequently rolling over short-term debt amplifies total cost exposure over time.

Memory tip: Picture a tall slow wave (long-term asset) vs. many fast small waves (short-term liability) - the single big wave looks dramatic, but the rapid-fire short waves cumulatively push further up the beach.

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