{"id":17594,"date":"2021-07-11T22:14:12","date_gmt":"2021-07-11T22:14:12","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=17594"},"modified":"2026-03-19T18:14:53","modified_gmt":"2026-03-19T18:14:53","slug":"compare-effective-durations-of-callable-putable-and-straight-bonds","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/compare-effective-durations-of-callable-putable-and-straight-bonds\/","title":{"rendered":"Effective Durations of Callable, Putable, and Straight Bonds"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Effect of rising interest rates on duration of a putable bond\",\r\n    \"text\": \"When interest rates rise, the effective duration of a putable bond most likely:\\n\\nA. Shortens.\\n\\nB. Lengthens.\\n\\nC. Equals that of a straight bond.\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is A.\\n\\nWhen interest rates rise, the put option becomes more valuable (in the money), allowing investors to sell the bond at a predetermined price and reinvest at higher yields. This limits price sensitivity and reduces the effective duration of the putable bond.\\n\\nB and C are incorrect. When interest rates fall, the put option is out of the money, and the bond behaves more like a straight bond.\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/5zZuTYmjxW8\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<h2>Callable Bonds<\/h2>\r\n<p>The effective duration of a callable bond <em>cannot<\/em> be greater than that of a straight bond.<\/p>\r\n<p>As interest rates rise above the coupon rate, the call option becomes out of money. Therefore, straight and callable bonds will have the same effective durations.<\/p>\r\n<p>On the other hand, when interest rates fall, the call option moves into the money, and the bond is most likely called. Thus, the call option reduces the effective duration of the callable bond relative to that of a straight bond. In other words, call options have limited upside potential.<\/p>\r\n<h2>Putable Bonds<\/h2>\r\n<p>The effective duration of a putable bond <em>cannot<\/em> exceed that of a straight bond.<\/p>\r\n<p>When interest rates fall below the bond\u2019s coupon rate, the put option will be out of money. In this case, the effective duration of a putable bond will be identical to that of a straight bond.<\/p>\r\n<p>When interest rates rise, the put option moves into the money. The bond is more likely to be put, meaning that its downward potential is limited. Therefore, the bond\u2019s effective duration is lower than that of a straight bond.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>When interest rates rise, the effective duration of a putable bond <em>most likely<\/em>:<\/p>\r\n<ol type=\"A\">\r\n\t<li>Shortens.<\/li>\r\n\t<li>Lengthens.<\/li>\r\n\t<li>Equals that of a straight bond.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is A.<\/strong><\/p>\r\n<p>When interest rates rise, the put option moves into the money. This limits price depreciation as the investor is more likely to put the bond and reinvest the bond\u2019s proceeds at a higher yield. Thus, the put option reduces the effective duration of the putable bond relative to that of a straight bond.<\/p>\r\n<p><strong>B and C are incorrect.<\/strong>\u00a0When interest rates fall below the coupon rate, the put option will be out of money. Therefore, the option will not be exercised. In this case, the effective duration of a putable bond will be identical to that of a straight bond.<\/p>\r\n<\/blockquote>\r\n<p>Reading 30: Valuation and Analysis of Bonds with Embedded Options<\/p>\r\n<p><em>LOS 30 (j) Compare effective durations of callable, putable, and straight bonds.<\/em><\/p>\r\n\n            <div \n                class=\"elfsight-widget-pricing-table elfsight-widget\" \n                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As interest rates rise above the coupon rate, the call option becomes out of money. Therefore, straight and callable bonds will have&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,472],"tags":[],"class_list":["post-17594","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-fixed-income","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Effective Duration of Callable and Putable Bonds<\/title>\n<meta name=\"description\" content=\"Learn how effective duration differs for callable, putable, and straight bonds, and how interest rate changes impact bond price sensitivity.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link 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