Answer: Effective duration.

Effective duration is the most appropriate measure for bonds with embedded options, such as callable bonds, because these bonds lack a well-defined internal rate of return (yield-to-maturity). Traditional yield duration metrics like modified and Macaulay durations are not applicable in such cases. Effective duration accounts for the potential changes in cash flows due to the embedded options, making it a more accurate measure of interest rate risk. Additionally, effective convexity is also a relevant measure for such bonds.

Author: LeetQuiz Editorial Team