CFA Level II ExamFixed IncomeMedium
A portfolio manager is analyzing a fixed-income portfolio and wants to understand how the yield curve's shape changes affect the portfolio's value. The manager is particularly interested in identifying bonds that are sensitive to changes in specific segments of the yield curve. Which of the following measures is most appropriate for this analysis?
- AModified duration
- BMacaulay duration
- CKey rate duration
- DEffective duration
Show answer & explanationAnswer & explanation
Correct answer: C. Key rate duration
Key rate duration measures a bond's sensitivity to a change in a specific spot rate (or 'key rate') along the yield curve, holding all other spot rates constant. This allows analysts to assess how a bond's price reacts to non-parallel shifts and changes in the shape of the yield curve.
Why the other options are wrong
- A. Modified duration is a measure of a bond's price sensitivity to a change in its yield to maturity, assuming a parallel shift in the yield curve.
- B. Macaulay duration is a measure of a bond's weighted average time to maturity and assumes a parallel shift in the yield curve.
- D. Effective duration is used for bonds with embedded options and assumes a parallel shift in the yield curve.
Key Rate Duration
Key rate duration measures the sensitivity of a bond's price to a 1 basis point change in a specific spot rate (key rate) on the yield curve, holding all other spot rates constant.
- Used for non-parallel yield curve shifts.
- Sum of key rate durations approximates total duration.
- Useful for managing yield curve shape risk.
Memory trick: Key rates unlock curve shape insights.