Question #51

Reading: Reading 25 The Term Structure and Interest Rate Dynamics

PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf

Page: 21

Status: Unattempted

Correct Answer: B

Part of Context Group: Q50-51
Shared Context
- The comment made by Ross is most likely: A) inaccurate with respect to the statement about spot rates, forward rates, and yields. B) inaccurate with respect to the statement about rolling down the yield curve. C) inaccurate in both respects.
Question
The most appropriate measure for Alex Allan to assess bond price sensitivity is:
Answer Choices:
A. key rate duration
B. effective duration
C. Macaulay duration
Explanation
Assuming an upward-sloping yield curve as a starting point, if short-term yields increase, but long-term yields remain constant, the yield curve will flatten. This is a non-parallel shift in the yield curve, which makes effective duration an inappropriate measure of bond price sensitivity. Key rate duration is the preferred measure for non-parallel shifts in the yield curve. Effective duration is only suitable for measuring the sensitivity of a bond's price to parallel shifts in the yield curve. Macaulay duration measures the weighted average length of time to receive the present value of a bond's cash flows and is inappropriate in this instance.
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