{"id":3321,"date":"2019-09-12T13:33:00","date_gmt":"2019-09-12T13:33:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=3321"},"modified":"2026-01-12T16:03:28","modified_gmt":"2026-01-12T16:03:28","slug":"effective-duration-interest-rate-risk","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/fixed-income\/effective-duration-interest-rate-risk\/","title":{"rendered":"Effective Duration-Measure of Interest Rate Risk"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Understanding Fixed-Income Risk and Return (2025 CFA Level I Exam \u2013 Fixed Income, Module 5)\",\n  \"description\": \"This video explains fixed-income risk and return concepts for the 2025 CFA Level I exam. Topics include sources of bond risk, measures of return, yield components, and how risk factors affect fixed-income securities. The lesson aligns with the CFA Institute Fixed Income curriculum.\",\n  \"uploadDate\": \"2022-06-01\",\n  \"duration\": \"PT1H01M\",\n  \"thumbnailUrl\": [\n    \"https:\/\/img.youtube.com\/vi\/ys7hMfL_EIs\/maxresdefault.jpg\"\n  ],\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=ys7hMfL_EIs\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/ys7hMfL_EIs\",\n  \"inLanguage\": \"en\",\n  \"isFamilyFriendly\": true,\n  \"publisher\": {\n    \"@type\": \"Organization\",\n    \"name\": \"AnalystPrep\",\n    \"url\": \"https:\/\/analystprep.com\/\"\n  }\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"An analyst should least likely use effective duration for a:\",\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is B. Effective duration is essential for the measurement of interest rate risk for complex bonds such as bonds with embedded call, put or convertible options but also for mortgage-backed securities. However, it is not as useful for floating-rate bonds.\"\n    },\n    \"suggestedAnswer\": [\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Convertible bond.\"\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Floating-rate bond.\"\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Residential mortgage-backed security.\"\n      }\n    ],\n    \"answerCount\": 3\n  }\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/ys7hMfL_EIs?si=6qqsLul7xBpduPE0\" title=\"YouTube video player\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe>\n\n\n<p>Another approach to assessing interest rate risk of a bond is to estimate the percentage change in price against a change in the benchmark yield curve, such as the government par curve. The effective duration is defined as the sensitivity of the price of a bond against a change in a benchmark yield curve. Below is the formula for calculation of effective duration (EffDur):<\/p>\n<p class=\"Text001\">$$EffDur=\\frac { { PV }_{ &#8211; }-{ { P }V_{ + } } }{ 2\\times \\Delta curve\\times { PV }_{ 0 } } $$<\/p>\n<p>Note: although they appear similar, the approximate modified duration and effective duration are different. The modified duration is a <em>yield duration <\/em>statistic that measures interest rate risk with reference to a change in the yield-to-maturity (\u0394Yield) of a bond. On the other hand, effective duration is a <em>curve duration <\/em>statistic that measures interest rate risk in terms of a parallel shift in the benchmark yield curve (\u0394Curve).<\/p>\n<h2><strong>Bonds with Call, Put, and Convertible Options<\/strong><\/h2>\n<p>The effective duration is an essential measure of interest rate risk for complex bonds, such as bonds with embedded call, put, or convertible options. The duration of a callable bond is not the sensitivity of the bond price to a change in yield-to-worst, such as the lowest of the yield-to-maturity, yield-to-first-call, yield-to-second-call, and so forth.<\/p>\n<p>The problem is the uncertainty that shrouds future cash flows because of the volatility of future interest rates. Therefore, callable bonds do not have a well-defined internal rate of return (yield-to-maturity), and yield duration statistics such as Modified and Macaulay durations do not apply. This, then, makes the effective duration the appropriate duration measure.<\/p>\n<h2><strong>Mortgage-backed Bonds<\/strong><\/h2>\n<p>Another fixed income security whose yield duration statistics such as Modified and Macaulay durations are not relevant is a mortgage-backed bond. As seen in the previous reading, the cash flows of a mortgage-backed bond are contingent on homeowners\u2019 ability to refinance debt at a lower rate.<\/p>\n<blockquote>\n<h3><strong>Question<\/strong><\/h3>\n<p>An analyst should <em>least likely<\/em> use effective duration for a:<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Convertible bond.<\/li>\n<li data-tadv-p=\"keep\">Floating-rate bond.<\/li>\n<li data-tadv-p=\"keep\">Residential mortgage-backed security.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>Effective duration is essential for the measurement of interest rate risk for complex bonds such as bonds with embedded call, put or convertible options but also for mortgage-backed securities. However, it is not as useful for floating-rate bonds.<\/p>\n<\/blockquote>","protected":false},"excerpt":{"rendered":"<p>Another approach to assessing interest rate risk of a bond is to estimate the percentage change in price against a change in the benchmark yield curve, such as the government par curve. The effective duration is defined as the sensitivity&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[9],"tags":[],"class_list":["post-3321","post","type-post","status-publish","format-standard","hentry","category-fixed-income","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Effective Duration &amp; Interest Rate Risk | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Effective duration measures a bond\u2019s sensitivity to interest rate changes by estimating price shifts relative to benchmark yield curve fluctuations.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" 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