Derivatives Foundation interview preparation

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100

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29

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19

Updated

September 2026

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All firmsMSMorgan Stanley4Nomura4Akuna Capital2Amundi2HSBC2PIMCO2Bank of America1Barclays1Citadel1DRW1Goldman Sachs1Jane Street1Millennium Management1Mizuho1Old Mission Capital1RCRBC Capital Markets1Scotiabank1UBS1Wells Fargo Securities1

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All topicsForwards and futures10Options basics8Option pricing7The Greeks10Volatility7Option strategies9Swaps and rates7Credit derivatives4Market structure and clearing6Indian derivatives8Trading and markets9Brainteasers6Fit9

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1. 055What is effective duration, and when would you use it instead of modified duration?Swaps and ratesIntermediatetechnicalAmundiRates · London · 2018

   Say this

   Effective duration is measured rather than derived: you shock the whole yield curve up and down by a small amount, reprice the bond with its options and cash flow rules intact, and read the sensitivity off the two prices. You use it whenever the cash flows themselves depend on rates — callables, putables, mortgages, floaters — because modified duration assumes they do not.

   Then walk it

   1. Formula: price down minus price up, divided by twice the initial price times the size of the shock. It is a numerical derivative, which is the whole point — you are not assuming a closed form.
   2. Modified duration is computed from fixed, known cash flows. The moment a bond is callable, the issuer's option changes the cash flows as rates move, so the analytical number is simply wrong.
   3. Callable bonds are the classic case. Rates fall, the call becomes likely, the expected life shortens, and duration falls — so the bond's price rise is capped. That is negative convexity, and effective duration captures it while modified duration cannot.
   4. Mortgage-backed securities are the extreme version, because prepayment behaviour is the option. Effective duration on an MBS moves sharply with rates, which is why convexity hedging by mortgage portfolios amplifies rate moves in the Treasury market.
   5. It is also the right measure for a floating-rate note, where the coupon resets. A floater has a long maturity and an effective duration of months, because its price barely responds to a level shift in rates.
   6. The caveat worth adding: effective duration is model-dependent, since repricing a callable requires an assumption about volatility and about how the issuer exercises. Two houses will produce different effective durations for the same bond, and the difference is a model choice rather than a data error. And the parallel-shift assumption is still in there — key rate durations are how you get past it.

   Where candidates lose it

   Treating effective and modified duration as synonyms, or defining effective duration with a formula but no reason to prefer it. Name a bond with embedded optionality — callable or mortgage — and say that its cash flows move with rates. That is the whole distinction.

   Expect next

   • What is the effective duration of a floating-rate note?
   • Why does a callable bond have negative convexity?
   • How does MBS convexity hedging move the Treasury market?

   Reported by candidates at Amundi (Rates, London, 2018). Source: Wall Street Oasis.

Firm tags come from public, anonymous candidate reports on Wall Street Oasis: strong signal, not sworn testimony. Firms are named as the places a question was reported, not as partners of Fin Maverick. Answers are written for this page to show how to think out loud; they are not scripts to recite.