When should I stop using modified duration and switch to effective duration?

Switch to effective duration when a rate move can change expected cash flows, not just discount rates.

Modified duration works best when promised cash flows stay fixed. That is usually fine for a plain corporate bond. It becomes unreliable for callable bonds, mortgage-backed securities, and other structures where falling or rising rates change prepayment or call behavior.

Example:

• Plain bond issued by Alder Port Logistics: use modified duration for small yield moves.
• Callable bond issued by Alder Port Logistics: use effective duration because the issuer may refinance if rates fall.

The exam signal is usually in the instrument description:

• callable
• putable
• mortgage-backed
• prepayment-sensitive
• option-embedded

If those words appear, ask whether expected cash flows move with rates. If yes, effective duration is the safer framework.