Fixed Income - Fixed Income Section 2
- Option : A
- Explanation : Modified duration is useful and accurate for small changes in yield but it is not useful and accurate for larger changes in yield.
27. A measure that is most appropriate to price bonds with embedded options is:
- Option : C
- Explanation : Effective duration is used to value bonds with embedded options. This duration considers changes in a benchmark yield curve and not the bond’s current YTM.
- Option : B
- Explanation : The modified duration and effective duration of an option free bond are identical only in the rare circumstance of an absolutely flat yield curve.
29. Which of the following statements is least accurate?
- A
Effective duration is the appropriate duration measure for a callable bond.
- B
The duration of a callable bond is the sensitivity of the bond price to change in the yield-to-worst.
- C
A callable bond does not have a well-defined internal rate of return, hence modified and Macaulay duration cannot be used.
- Option : B
- Explanation : The yield to worst is the lowest of the yield to maturity, yield to first call, yield to second call and so forth. The duration of a callable bond is not the sensitivity of the bond price to change in the yield-to-worst.
- Option : A
- Explanation : The interest rate risk is the sensitivity of a bond to parallel shifts of the yield curve. The yield curve risk is a bond’s sensitivity to changes in the shape of the yield curve.
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