CFA Level I · CFA Level I Exam · Curve-Based and Empirical Fixed-Income Risk Measures
A callable bond trades at a price close to its call price after a sharp fall in interest rates. Compared with an otherwise identical non-callable bond, the callable bond's effective duration is most likely:
The callable bond's effective duration is most likely shorter. With rates low, the call option is valuable and caps price appreciation, so the price responds less to curve changes than the price of an otherwise identical non-callable bond, which continues to rise as rates fall.
- AshorterCorrect
- Bthe same
- Clonger
Explanation
When rates are low, the call option is near or in the money, so the bond's price is capped and rises little when rates fall. Its price sensitivity, and so its effective duration, is lower than that of the non-callable bond, which keeps appreciating.
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