For large interest rate increases,duration ________ the fall in security prices,and for large interest rate decreases,duration ________ the rise in security prices.
A)overpredicts; overpredicts
B)overpredicts; underpredicts
C)underpredicts; overpredicts
D)underpredicts; underpredicts
E)None of these choices are correct.

Question

Quizplus · Accepted Answer

Duration is a measure of a bond's sensitivity to changes in interest rates. It measures the average timing of the bond's cash flows. The longer the duration, the more sensitive the bond price is to changes in interest rates.

For large interest rate increases, the duration overpredicts the fall in security prices. This means that the bond prices will fall more than what the duration predicts. This is because investors are more likely to sell their bonds and move into higher-yielding investments, causing the bond prices to fall even more.

For large interest rate decreases, the duration underpredicts the rise in security prices. This means that the bond prices will rise more than what the duration predicts. This is because investors are more likely to hold onto their bonds for their higher yields, causing the bond prices to rise even more.

For Large Interest Rate Increases,duration ________ the Fall in Security