The effective duration is calculated using the formula:

$\text{Effective Duration} = \frac{PV_{-} - PV_{+}}{2 \times \Delta \text{Curve} \times PV_0}$

Where:

• $PV_{-}$ is the bond price when the benchmark yield is decreased (103).
• $PV_{+}$ is the bond price when the benchmark yield is increased (98).
• $PV_0$ is the current bond price (100).
• $\Delta \text{Curve}$ is the change in the benchmark yield (0.0025 for 25 bps).

Plugging in the values:

$\text{Effective Duration} = \frac{103 - 98}{2 \times 0.0025 \times 100} = 10.0$

Why is this correct? Effective duration and effective convexity are the most appropriate measures of interest rate risk for bonds with embedded options, as they account for potential changes in cash flows due to the options.