Effective duration

CFA Level I
#1

Changes in a fixed-coupon bond’s cash flows associated with changes in yield would be reflected in the bond’s:

A) effective duration. B) modified duration. C) Macaulay Duration

Effective duration and effective convexity capture the effects from changes in a bond’s cash flows when the yield changes. For this reason, they are the appropriate measures of interest rate sensitivity for bonds with embedded options.

Well, it never says it is an embedded option, right?

Another question, if it was this same question, no embedded option, the answer would be Macaulay Duration, not Modified Duration?

Thank you

#2

Macaulay duration and modified duration assume that the cash flows do not change when the yield changes.

Effective duration allows for changes in cash flows when the yield changes.

The bond doesn’t have to have embedded options for the cash flows to change. Floating-rate bonds have changing cash flows.

#3

Thank you S2000

#4

My pleasure.