> Suppose I were to give you $100, in return for your promise to give it back when I wanted it and pay me 0.27% annualized interest in the meanwhile. Suppose you invested this in a virtually riskless bond, perhaps a mortgage-backed security with government backing, offering 2.53% annualized interest. You’d earn $2.26 in net interest in a year.
How would you rectify the duration mismatch between the on-demand deposit (of $100) with the multi-year mortgage-backed security?
For example, if the rate of interest increases, my $100 — that you invested in bonds — will now be worth less than $100 (since the price of the bond has fallen). How will you be able to honor my withdrawal when you’re insolvent?
How would you rectify the duration mismatch between the on-demand deposit (of $100) with the multi-year mortgage-backed security?
For example, if the rate of interest increases, my $100 — that you invested in bonds — will now be worth less than $100 (since the price of the bond has fallen). How will you be able to honor my withdrawal when you’re insolvent?