NASAA Series 65, Uniform Investment Adviser Law ExaminationClient Investment Recommendations and StrategiesMedium
A client is concerned about the impact of rising interest rates on their bond portfolio. They ask their investment adviser about the measure that best quantifies a bond's price sensitivity to changes in interest rates. The adviser should describe:
- ADuration
- BCredit rating
- CCoupon rate
- DYield to maturity
Show answer & explanationAnswer & explanation
Correct answer: A. Duration
Duration is the primary measure of a bond's interest rate sensitivity. It estimates the percentage change in a bond's price for a 1% change in interest rates. Higher duration means greater sensitivity to interest rate fluctuations.
Why the other options are wrong
- B. Credit rating assesses the issuer's ability to meet its financial obligations, not the bond's price sensitivity to interest rates.
- C. Coupon rate is the annual interest payment, not a measure of interest rate sensitivity.
- D. Yield to maturity is the total return anticipated on a bond if it is held until it matures, not its price sensitivity.
Bond Duration
A measure of a bond's interest rate sensitivity, representing the weighted average time until a bond's cash flows are received.
- Higher duration means greater price sensitivity to interest rate changes.
- Used by investors to manage interest rate risk in bond portfolios.
- Modified duration is a common method for approximating price change.
Memory trick: Bonds have 'DURATION' for sensitivity.