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    Question

    An NPS pension fund has a liability profile highly

    sensitive to 5 year interest rate changes. The fund manager uses ALM to immunize duration. Suddenly, 5-year bond yields rise by 1.5%, and the duration of assets mismatches liabilities by +0.5 years. What is the most appropriate immediate action?
    A Increase bond portfolio duration Correct Answer Incorrect Answer
    B Reduce bond portfolio duration Correct Answer Incorrect Answer
    C Hedge using interest rate swaps to shorten duration Correct Answer Incorrect Answer
    D No action required as liabilities are fixed Correct Answer Incorrect Answer
    E Switch investments to equity Correct Answer Incorrect Answer

    Solution

    With asset duration exceeding liability duration, a rate rise causes asset value to drop more than liability—a duration gap. The fund should hedge by entering into interest rate swaps or selling long-duration bonds to shorten asset duration and restore immunization.

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