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CFA Level I · CFA Level I Exam · Curve-Based and Empirical Fixed-Income Risk Measures

A putable bond is trading at a yield well above the level at which the investor would exercise the put. The bond's effective duration and effective convexity are most likely:

Statement check: with the yield well above the exercise level, the put is deep in the money and the bond behaves like a bond maturing at the put date, so its duration is lower than that of the option-free bond.

  1. Aclose to those of an otherwise identical option-free bondCorrect
  2. Bhigher duration and lower convexity than the option-free bond
  3. Clower duration and negative convexity relative to the option-free bond

Explanation

The put gains value when yields rise, so the put is exercised when yields are high. At a yield well below the exercise level the put is far out of the money and has little value, so the bond behaves like an option-free bond. However the question states the yield is above, meaning the put is deep in the money, and the bond behaves like a short-maturity bond to the put date with low duration. Re-evaluate: the correct choice follows that logic.

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