honeycfa

Which of the following statements about duration is most accurate?

A) Modified duration is the most appropriate measure of interest rate sensitivity for bonds with embedded options.

B) Effective duration accounts for changes in a bond’s cash flows resulting from interest rate changes.

C) Effective duration is calculated from past price changes in response to changes in yield.

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Neither Macaulay nor modified duration is an appropriate measure of interest rate risk for bonds with embedded options. Macaulay duration does not take the current YTM into account as modified duration does. Effective duration, however, explicitly takes into account changes in a bond’s cash flows due to interest rate changes and is calculated from expected price changes in response to a given increase or decrease in yield.