What do you mean by modified duration?

What do you mean by modified duration?

Modified duration is a formula that expresses the measurable change in the value of a security in response to a change in interest rates. Modified duration follows the concept that interest rates and bond prices move in opposite directions.

What is difference between duration and modified duration?

Duration measures a bond’s or fixed income portfolio’s price sensitivity to interest rate changes. Macaulay duration estimates how many years it will take for an investor to be repaid the bond’s price by its total cash flows. Modified duration measures the price change in a bond given a 1\% change in interest rates.

What is the purpose of modified duration?

The modified duration provides a good measurement of a bond’s sensitivity to changes in interest rates. The higher the Macaulay duration of a bond, the higher the resulting modified duration and volatility to interest rate changes.

What does a high modified duration mean?

So higher the modified duration, higher is the risk of price fluctuation and lower the modified duration, the lower would be the price fluctuation. Basically, the price of a bond and the interest rate have inverse relationship, i.e. if the interest rates rise, the price of the bond would fall and vice versa.

Why is modified duration better than maturity?

Modified duration is a slightly more involved calculation that takes into account the effects of interest-rate movements. Effective duration is another, still-more complicated measure used to assess interest-rate sensitivity when callable securities (those that may be paid off before maturity) are involved.

Can Modified duration be negative?

The price-yield relationship is negatively correlated; when prices go down, the implied yield goes up. The minus sign allows the modified duration to be positive for a normal bond.

What is the formula for approximate modified duration?

The modified duration is an adjusted version of the Macaulay duration, which accounts for changing yield to maturities. The formula for the modified duration is the value of the Macaulay duration divided by 1, plus the yield to maturity, divided by the number of coupon periods per year.

What does modified duration mean?

Modified duration is a formula that expresses the measurable change in the value of a security in response to a change in interest rates. Modified duration follows the concept that interest rates and bond prices move in opposite directions.

What is the difference between duration and maturity?

Effective duration and average maturity apply if you have a portfolio consisting of several bonds. While maturity refers to when a bond expires, or matures, duration is a measure of the bond’s price sensitivity to changes in interest rates. While the two concepts are related, they also differ significantly.