Reynaldo and Apple are training a new analyst, Norah Spears. They ask Spears what she knows about duration and convexity. Spears replies with four statements:
A. Spears is correct with respect to Statement 3, but incorrect with respect to Statement 1. B. Spears is correct with respect to Statement 2, but incorrect with respect to Statement 4. C. Spears is correct with respect to all four statements.
Effective duration is a better measure than modified duration for bonds with embedded options because modified duration does not explicitly recognize the change in cash flows that will occur in a bond with embedded options as yield changes. Therefore, Statement 1 is incorrect. The other four statements made by Spears are correct.
