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CFA Level I · CFA Level I Exam · Yield-Based Bond Duration Measures and Properties

A bond has a Macaulay duration of 7.0 years. An investor with a 10-year horizon is most likely exposed, following an immediate parallel rise in yields, to which outcome?

When the horizon is longer than Macaulay duration, reinvestment risk dominates price risk. After an immediate rise in yields, coupons are reinvested at higher rates and this gain outweighs the price decline, so the investor's realized horizon return rises above the original yield.

  1. AReinvestment risk dominates price risk, so the horizon return risesCorrect
  2. BPrice risk dominates reinvestment risk, so the horizon return falls
  3. CPrice risk and reinvestment risk exactly offset each other

Explanation

The horizon (10 years) exceeds Macaulay duration (7 years). Over a long horizon, reinvestment income dominates the lower price, so a yield rise increases the horizon return. Option B describes a horizon shorter than duration; option C applies only when they are equal.

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