CFA Level II ExamFixed IncomeEasy
A portfolio manager is analyzing a fixed-income portfolio's sensitivity to shifts in the yield curve. They observe that a parallel shift in the yield curve does not adequately explain the portfolio's price changes. Which of the following tools would be most appropriate to better understand the portfolio's exposure to non-parallel yield curve movements?
- AEffective Duration
- BKey Rate Duration
- CModified Duration
- DMacaulay Duration
Show answer & explanationAnswer & explanation
Correct answer: B. Key Rate Duration
Key rate duration measures the sensitivity of a bond's or portfolio's value to a change in a specific point (key rate) on the yield curve, holding other rates constant. This allows for the analysis of non-parallel shifts, such as twists and humps, which modified and effective duration cannot capture.
Why the other options are wrong
- A. Effective duration accounts for embedded options but still typically assumes a parallel shift.
- C. Modified duration assumes a parallel shift in the entire yield curve.
- D. Macaulay duration is a measure of a bond's weighted-average time to maturity and also assumes a parallel shift.
Key Rate Duration
A measure of a bond's or portfolio's sensitivity to a change in a specific point on the yield curve, holding other rates constant.
- Useful for analyzing non-parallel yield curve shifts.
- Sum of all key rate durations approximates modified duration.
- Helps identify exposure to twists and humps in the yield curve.
Memory trick: Keys Unlock Curve's Complexities.