The option adjusted duration will approach the duration to maturity,when
A) Interest rates are significantly above the coupon rate because the option has very little chance of being called, and the call option will have very little value.
B) Interest rates are significantly below the coupon rate because the option has very little chance of being called, and the call option will have very little value.
C) Interest rates are significantly above the coupon rate because the option has a high chance of being called, and the call option will have significant value.
D) Interest rates are significantly below the coupon rate because the option has a high chance of being called, and the call option will have significant value.
E) None of the above.

Question

Quizplus · Accepted Answer

Option adjusted duration takes into account the potential impact of optionality on a bond's cash flows. When interest rates are significantly above the coupon rate, there is a greater likelihood that the bond will be called, and the option to call becomes more valuable. However, the value of the option decreases as interest rates rise, thus reducing the degree of optionality in the bond. As a result, the option adjusted duration will approach the duration to maturity, indicating that the bond's cash flows are becoming more predictable and less susceptible to changes in interest rates.

The Option Adjusted Duration Will Approach the Duration to Maturity,when