Question on Duration

CFA Level I Fixed Income
#1

Hi,

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

  1. Effective duration

  2. Modified duration

  3. Macaulay Duration

I answered 2 because I thought modified duration was a yield duration statistic, not a curve duration statistic but the answer is 1. Can anyone explain why the answer is 1 and not 2?

thanks!

#2

If the bond pays a fixed coupon and has no embedded options, then its modified duration and effective duration are equal, so either answer would be correct.

If the bond does not pay a fixed coupon, or has embedded options, then its modified duration will likely be different from its effective duration; in that case, effective duration is correct and modified duration is not.

So . . . effective duration is a better answer.

#3

Thank you.

So this question is asked in an ambiguous way. It clearly states fixed coupon bond and there is no mention of an embedded option.

#4

Yup.