Explanation:
Effective duration and effective convexity are the most appropriate measures of interest rate risk for bonds with embedded options. The modified duration and effective duration of an option-free bond are identical only when the yield curve is perfectly flat. This is because the pricing models for complex securities, such as callable and mortgage-backed bonds, include assumptions about issuer behavior, which are not affected by small changes in benchmark rates. Therefore, the correct answer is C.
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Effective duration is:
A
A measure of interest rate risk primarily used for bonds with embedded options, though it can also supplement traditional bonds.
B
An estimate of interest rate risk that is most accurate when the assumed change in benchmark rates is minimal.
C
Equivalent to the modified duration of an option-free bond solely under the condition of a perfectly flat yield curve.