Sign up  |  Log in

Total expected return - expected duration vs current duration

Dear all,

EOC questions for reading 23 yield curve strategies, question 14.

Task is to calculate the components of total expected return of a portfolio. One component is the expected change in price based on yield view. So far so clear. In the mentioned question, to calculate we have the current as well as expected effective duration given. From the answer and also from the CFA text it seems that we always have to take the expected effective duration (and also convexity) for the portfolio (at the horizon), but there is no eleboration on why.

Is my understanding true and does somebody have an explanation?

The best just got better. Schweser's upgraded content and redesigned study platform are exactly what you need to pass the Level III exam. Save 10% when you preorder a Premium Package for a limited time.

I think it has to do with the forecasted yield. If a bond has optionalities then the effective duration will depend on how rates will change. Effective duration includes optionalities while modified duration does not. So the duration measure is consistent with the yield view.

Example: callable bond and view is rates decline. Expected effective duration will be lower than current modified duration. Use the measure that’s consistent with your view.

Okay, that is a good argument, thank you for the explanation. Would have been great if it was mentioned anywhere in the studies, especially since there is a question that is specifically targeting this difference….

It is mentioned once in Reading 21 section Decomposing expected returns with once sentence though would would have nice if it could have been mentioned in the Yield Curve Strategies Reading again though.

But to clarify: there is a question in reading 23 where it uses the Effective Duration Measure opposed to the MD for a Barbell structure. The barbell as far as I could see had no optionality, then why use the effective duration method?

About to ask the same. In formula itself, curriculum was referring to MD. But in the practice question set, it gives you MD and ED, a clear trap, and the answer goes to ED. 

Why?

BUMP. Having the same question! The text explicitly says to use modified duration but straight out uses the effective duration. Any help is much appreciated.

If ED is different than MD, clearly its has options,

125mph wrote:
If ED is different than MD, clearly its has options,

Not necessarily.

It could be a floater, or an inverse floater.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/