Decomposing Expected Return (Bonds)...ModDur or Eff.Dur to be used?

Hi guys,

One part of the expected bond return is change in price based on investor’s views of yields and yield spreads.

And the calculation is (reading 22, page 24): [-_ ModDur _ x Change in Yield] + [1/2 x Convexity x (Change in yield^2)]

However, in the EOC 14 (reading 24) effective duration is used.

Could you someone please advise when should ModDur be used and when should Eff.Dur be used?

The second is rather used for bonds with embedded options.

Yes, I thought so too, but in the EOC, there is no mention of any options. And the exhibit provide Eff.Dur and Mod.Dur values and I’m still a bit confused why the answer used Eff.Dur in the calculation.

I think Effective Duration measure is also more precise and, if you’re able so, rather use ED instead MD. MD is based on Macaulay and is old-fashioned measure, imo.

For fixed coupon bonds without embedded options, effective duration is the same as modified duration.

Therefore, effective duration encompasses fixed rate option-free bonds, floating rate bonds, and bonds with embedded options.

Not to beat a dead horse… But it literally addresses this in the paragraph below the equation in the CFA text (page 24).