1. The following table shows the annual cash flow of a security that will mature in three years. The current interest rate is (8 per cent per annum). Column (3) in the table shows the discounting of the corresponding year.

(1)	(2)	(3)
t	CFt	DFt
1	$1,000,000	0.9259
2	$1,000,000	0.8573
3	$1,000,000	0.7938

(i) Calculate the security's duration?

(ii) Would you expect the duration of the security to be shorter or longer than its maturity? Why?

(3 marks)

2. If you are working with the asset-liability committee in one of the big banks and the committee knew that the interest rates will increase within the next six months. How can banks take advantage of this opportunity?

1. What will you do if the repricing gap is positive or negative?

(ii) Would it be possible to adjust the repricing Gap in a 6-month time?

(iii) In light of what you have learned about interest rate risk, what else can you do to deal with this situation?

(3 marks)