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

An analyst compares a callable bond with an otherwise identical option-free bond. When market yields fall sharply to well below the call-exercise level, the effective duration of the callable bond is most likely:

The callable bond's effective duration is lower than that of the option-free bond. With yields well below the call level, the issuer is likely to call, which caps price appreciation and shortens expected life, reducing the bond's sensitivity to further curve declines.

  1. Alower than that of the option-free bondCorrect
  2. Bequal to that of the option-free bond
  3. Chigher than that of the option-free bond

Explanation

As yields fall, the call becomes likely to be exercised, so the callable bond's price rises little (negative convexity) and its price sensitivity declines. Its effective duration is therefore lower than that of the option-free bond. It would be higher only for a putable bond in rising yields.

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