Sutherland then turns his attention to measures of duration for MBS-CMOs. He knows that MBS-CMO duration can be calculated by using Monte Carlo simulation, but that cash flow duration is an alternative measure. He believes that the cash flow duration measure is more reliable than Monte Carlo simulation because the former uses static principal prepayment assumptions to determine the bond values used to calculate the effective duration. Is Sutherland’s belief about the reliability of the cash flow duration measure most likely correct? Select exactly 1 answer(s) from the following: A. Yes. B. No, because the pricing series data used to calculate cash flow duration may not be accurate. C. No, because cash flow duration can only be used when cash flows are not affected by changes in interest rates (i.e., non callable bonds). D. No, because cash flow duration is based on naïve assumptions of how prepayment rates change over the life of an MBS for given interest rate changes. What is the correct answer for this one and why? CFAI’s explanation isn’t helping me.
D Curriculum p.304
C
d edit. - static process - naive assumptions - CF changes as interest rate change - superior to Modified duration… inferior to effective duration