| Modified duration of a bond |
Around the formula...
The modified duration of a bond measures the
percentage change in its price for a given change in interest rates. The price
of a bond with a modified duration of 4 will increase by 4% when interest rates
fall from 7% to 6%, while the price of another bond with a modified duration of
3 will increase by just 3%.
From a mathematical standpoint, modified duration can be defined as the absolute
value of the first derivative of a bond's price with respect to interest rates,
divided by the price:
where r is the market rate and Ft the cash flows generated by the
bond.
