These bonds all have a maturity of three years and the same credit rating. Bonds #4 and #5 are identical to Bond #3, an option- free bond, except that they each include an embedded option.

1) The effective duration of Bond #6 is:

A. higher than 3

B. lower than or equal to 1

C. higher than 1 but lower than 3

2) In Exhibit 2, the bond whose effective duration will lengthen if interest rates rise is:

A) Bond #5

B) Bond #3

C) Bond #4

3) The effective duration of Bond #4 is closest to:

A) 1.88

B) 3.77

C) .76

Exhibit 2 Bonds Issued by RW, Inc. \begin{tabular}{lcc} Bond & Coupon & Special Provision \\ \hline Bond #3 & 4.00% annual & \\ Bond #4 & 4.00% annual & Callable at par at the end of years 1 and 2 \\ Bond #5 & 4.00% annual & Putable at par at the end of years 1 and 2 \\ Bond \#6 & One-year Libor annually, & \\ & set in arrears & \\ \hline \end{tabular} Exhibit 2 Bonds Issued by RW, Inc. \begin{tabular}{lcc} Bond & Coupon & Special Provision \\ \hline Bond #3 & 4.00% annual & \\ Bond #4 & 4.00% annual & Callable at par at the end of years 1 and 2 \\ Bond #5 & 4.00% annual & Putable at par at the end of years 1 and 2 \\ Bond \#6 & One-year Libor annually, & \\ & set in arrears & \\ \hline \end{tabular}