long matuirty bonds have long duration so an investor w/ low risk tolerance shouldnt invest in long maturity bonds?? or they shouldnt invest in bonds w/ long EFFECTIVE DURATION. i guess im confused between effective duration w/ duration. are they the same thing??
You can view them as the same thing for exam purposes. The reason why an investor with low risk tolerance shouldn’t invest in long maturity bonds (high duration) is that the higher the duration, the higher your risk exposure when interest rate changes.
The low risk tolerance criterion should be viewed in a portfolio context, rather than used to evaluate single securities. I wouldn’t put short term liquidity needs in a long duration bond - because the risk of interest rates changing adversely and wiping out a portion of value is substantial. But if there are long duration liabilities, it may be appropriate for a risk averse investor to have some long duration assets matched to them. A risk averse person may prefer to have a long duration bond to cover these rather than trying to get them covered by hoping for equities to outperform bonds (which is likely, but generally riskier).
to anser the initial question, effective duration essentially is “duration” only adjusted for any features imbedded the bond (read: callable, putable, etc). There is no way they are going to test whether we know that or not. I agree with LotusGuy… “nothing to see here, let’s move on”.
effective duration and duration are the same thing.
Hmmm… A bus and a school bus are the same thing. Sort-of.
JoeyDVivre Wrote: ------------------------------------------------------- > Hmmm… > > A bus and a school bus are the same thing. > Sort-of. +1
Effective duration - remove effects of embedded options.
CFAAtlanta Wrote: ------------------------------------------------------- > Effective duration - remove effects of embedded > options. no no no, effective duration COUNTS effect of embedded options From investopedia: “A duration calculation for bonds with embedded options. Effective duration takes into account that expected cash flows will fluctuate as interest rates change.”
oops, you are right - neuron misfiring!!!
i think effective duration is take into consideration of the covexity factor as well, correct? if thats case, it should be the figure to use .