A fixed income security’s current price is 101.45. You estimate that the price will rise to 103.28 if interest rates decrease 0.25% and fall to 100.81 if interest rates increase 0.25%. The security’s effective duration is closest to:
B is correct because the effective duration equals
(Price if rates fall – Price if rates rise)/2 × Current price × Change in rates)
= (103.28 – 100.81)/( 2 × 101.45 × 0.0025) = 4.87.