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CFA Level I · CFA Level I Exam · Yield-Based Bond Convexity and Portfolio Properties

Compared with an otherwise identical option-free bond, a callable bond's effective duration is most likely to be:

A callable bond's effective duration is lower than the option-free bond's when yields fall near the call price. The issuer is likely to call, which shortens expected cash flows and caps price appreciation, reducing price sensitivity to further yield declines.

  1. Alower when yields fall to levels near the call price, because price appreciation is cappedCorrect
  2. Bequal to the option-free bond's at all yield levels, because coupons and maturity match
  3. Chigher when yields fall, because the call option extends the expected cash flow timing

Explanation

When yields fall, the call becomes likely to be exercised, shortening expected life and capping price gains (negative convexity), so effective duration falls below that of the option-free bond. Equal duration ignores the option. Extension of cash flows happens when yields rise, not fall.

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