At is quarerly meting, the trustees of the National Baggage Handlers Pension Fund deviewed the status of its bond portfolio. The portfolio is managed by William Renfro of Wiser and Wiser Management Company. The portfolio consists of 20% Treasury bonds. 10% corporate bonds that are noncallable for the life of the bonds, 30%6 callable corporate hands, and 40% mortgage-backed securities. The report provided by Wiser and Wiser includes the following information for each bond in the portfolio: (1) modified duration and (2) effective duration. The portfolio's modified duration and effective duration were reported to be 5 and 3, respectively. Renfro attended the board meeting to answer any questions that the trustees might have. Nancy Weston, one of the trustee for the fund. prepared the following list of questions: a. What does the duration of a bond mean and how should the board interpret the portfolio duration? b. Why is the modified duration and effective duration for each Treasury bond and noncallable corporate bond the same? What is the appropriate duration measure, effective duration or modified duration? d. How were the effective duration measures obtained? c. What are the limitations in using duration? The minutes of the board meeting indicated the following response by Mr. Renfro to cash of these questions:

Duration is a measure of the approximate weighted average life of a bond or a bondor a bond portfolio. For example, a portfolio duration of 5 means that the fund will realize the return of the amount invested (in present value terms) in about 5 years. b. Because the Treasury bonds in the portfolio are noncallable, modified duration is the same as effective duration. The same is true for the corporate bonds that are noncallable for life. c. The appropriate measure is the effective duration since it rakes into account the option embedded in the bonds held in the portfolio. d. We obtained the effective duration from various sources-dealers firms and commercial vendors. There is a standard formula chat all of these sources use to obtain the effective duration. Sometimes, a source may provide an effective duration that is not logical and we override the value by using the modified duration. For example, for some of the collateralized mortgage obligations, one vendor reported an effective duration of 40. This value was obviously wrong since the underlying collateral is 30-year loans; therefore, the duration cannot exceed 30. Moreover, for some of the CMOs, the duration is negative and this is obviously wrong. Again, in such instances we use the modified duration. e. Duration is only a good measure for small changes in yield and assumes that the yield curve will shift in a parallel fashion. However, if these assumptions are satisfied, rwo portfolios with the same duration will perform in exactly the same way. You are employed by Pension Consultants, a consultant to the labor union. You have been given the minutes of the meeting of the board of trustees with the responses of Mr. Renfo to the questions of Ms. Weston. Prepare a report indicating whether you agree or disagree with Mr. Renfro's responses.