Answer: Duration mapping replaces the portfolio with a zero-coupon bond with maturity equal to the duration of the portfolio.

D is correct. With duration mapping, a portfolio is replaced by a zero-coupon bond with maturity equal to the duration of the portfolio. This method simplifies the risk assessment of a portfolio by representing it as a single zero-coupon bond, which is easier to analyze and manage. The duration of the portfolio reflects the weighted average time to receive the cash flows, and by mapping the portfolio to a zero-coupon bond with the same duration, the manager can more easily assess the portfolio's interest rate risk. A is incorrect because cash-flow mapping groups cash flows into maturity brackets, not buckets based on their size. This method takes into account the timing and amount of cash flows and discounts them using the appropriate zero-coupon rates. B is incorrect as cash-flow mapping uses the appropriate zero-coupon rate as the discount factor for each cash flow, rather than using the average rates in each risk group. C is incorrect because principal mapping is a simpler method that only considers the timing of redemption payments and does not account for correlations among zero-coupon bonds with different maturities. It is cash-flow mapping that incorporates these correlations.

Author: LeetQuiz Editorial Team