The interest rate risk of a fixed-rate bond with an embedded call option is best measured by:
A) effective duration.
B) modified duration.
C) Macaulay duration.

Question

Quizplus · Accepted Answer

Effective duration measures the sensitivity of a bond's price to changes in interest rates, taking into account any embedded options such as call options. Modified duration and Macaulay duration also measure interest rate risk, but do not fully capture the impact of embedded options. Therefore, effective duration is the best choice for measuring interest rate risk of a fixed-rate bond with an embedded call option.

The Interest Rate Risk of a Fixed-Rate Bond with an Embedded