Reading 69: Introduction to the Measurement of Interest R style, between, standard, effective, difference

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1.One major difference between standard convexity and effective convexity is:

A)   standard convexity reflects any change in estimated cash flows due to embedded options.

B)   effective convexity is Macaulay's duration divided by [1+yield/2].

C)   effective convexity is Macaulay's duration multiplied by [1+yield/2].

D)   effective convexity reflects any change in estimated cash flows due to embedded bond options.

2.The distinction between modified convexity and effective convexity is that:

A)   effective convexity accounts for changes in cash flows due to embedded options, while modified convexity does not.

B)   modified convexity becomes less accurate as the change in yield increases, but effective convexity corrects for this.

C)   different dealers may calculate modified convexity differently, but there is only one formula for effective convexity.

D)   modified convexity is only meaningful for positive changes in yield, while effective convexity can be used for either positive or negative changes in yield.

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答案和详解如下：

1.One major difference between standard convexity and effective convexity is:

A)   standard convexity reflects any change in estimated cash flows due to embedded options.

B)   effective convexity is Macaulay's duration divided by [1+yield/2].

C)   effective convexity is Macaulay's duration multiplied by [1+yield/2].

D)   effective convexity reflects any change in estimated cash flows due to embedded bond options.

The correct answer was D)

The calculation of effective convexity requires an adjustment in the estimated bond values to reflect any change in estimated cash flows due to the presence of embedded options. Note that this is the same process used to calculate effective duration.

2.The distinction between modified convexity and effective convexity is that:

A)   effective convexity accounts for changes in cash flows due to embedded options, while modified convexity does not.

B)   modified convexity becomes less accurate as the change in yield increases, but effective convexity corrects for this.

C)   different dealers may calculate modified convexity differently, but there is only one formula for effective convexity.

D)   modified convexity is only meaningful for positive changes in yield, while effective convexity can be used for either positive or negative changes in yield.

The correct answer was A)

Effective convexity is the appropriate measure to use for bonds with embedded options because it takes into account the effect of the embedded options on the bond’s cash flows.