Explanation

When computing the duration of a bond portfolio as a weighted average of time to receipt of aggregate cash flows (also known as Macaulay duration), a key limitation is that it assumes the yield curve shifts in a parallel manner. This means it assumes that interest rates for all maturities change by the same amount.

Key Points:

1. Parallel Yield Curve Shift Assumption: Duration measures are based on the assumption that when interest rates change, they change by the same amount across all maturities. In reality, yield curves rarely shift in a perfectly parallel fashion.

2. Theoretical Validity: Option A is incorrect because this method is theoretically valid for measuring interest rate sensitivity under the parallel shift assumption.

3. Practical Application: Option B is incorrect because duration is actually widely used in practice despite its limitations.

4. Real-World Limitations: In practice, yield curves can:

   • Steepen (long-term rates rise more than short-term rates)
   • Flatten (short-term rates rise more than long-term rates)
   • Twist (some maturities rise while others fall)

5. Alternative Measures: For non-parallel shifts, more sophisticated measures like:

   • Key rate duration
   • Effective duration
   • Convexity adjustments are needed to better capture interest rate risk.

Correct Answer: C - The weighted average duration approach assumes parallel yield curve shifts, which is a significant disadvantage in real-world applications where yield curve movements are often non-parallel.