Chartered Financial Analyst (CFA) Practice Exam Level 2

The correct implication of having a lower market yield on bond duration is that it leads to a higher duration due to a higher price. This occurs because bond prices and yields have an inverse relationship. When market yields decrease, the prices of existing bonds increase. Duration measures the sensitivity of a bond's price to changes in interest rates. It reflects the weighted average time before a bond's cash flows are received. When the yield decreases, it indicates that the bond pays relatively more in present value terms compared to its market price, thereby increasing its duration. This is particularly relevant for bonds with longer maturities and lower coupon rates, as their cash flows are more heavily weighted towards the back end of the payment schedule, making their duration more sensitive to changes in yield. In summary, as yields fall, bond prices rise, leading to an increase in duration. This is an essential aspect to consider for fixed income investment strategies, especially in environments of declining interest rates.