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LOS h: Differentiate between modified convexity and effective convexity.ffice ffice" />
Q1. The distinction between modified convexity and effective convexity is that:
A) different dealers may calculate modified convexity differently, but there is only one formula for effective convexity.
B) modified convexity becomes less accurate as the change in yield increases, but effective convexity corrects for this.
C) effective convexity accounts for changes in cash flows due to embedded options, while modified convexity does not.
Correct answer is C)
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.
Q2. One major difference between standard convexity and effective convexity is:
A) effective convexity is Macaulay's duration divided by [1 + yield/2].
B) effective convexity reflects any change in estimated cash flows due to embedded bond options.
C) standard convexity reflects any change in estimated cash flows due to embedded options.
Correct answer is B)
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.
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发表于 2009-4-6 19:18
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