The option adjusted duration will approach the duration to maturity, when
A) interest rates are significantly above the coupon rate because the option has very little chance of being called, and the call option will have very little value.
B) interest rates are significantly below the coupon rate because the option has very little chance of being called, and the call option will have very little value.
C) interest rates are significantly above the coupon rate because the option has a high chance of being called, and the call option will have significant value.
D) interest rates are significantly below the coupon rate because the option has a high chance of being called, and the call option will have significant value.
E) None of these are correct.

Question

Quizplus · Accepted Answer

Option adjusted duration reflects the effect of any embedded options in a bond, such as a call option, on the bond's duration. When interest rates are significantly above the coupon rate, the likelihood of the bond being called (exercising the call option) decreases, since the issuer would not want to call a bond with a high coupon rate and replace it with a new bond with a lower coupon rate. As a result, the call option will have very little value, and the option adjusted duration will approach the duration to maturity.

The Option Adjusted Duration Will Approach the Duration to Maturity