Modified Duration

Modified duration is a derivative of Macaulay duration that specifically measures the percentage price change of a bond for a given change in yield. It is the most common measure of interest rate sensitivity used by traders and portfolio managers.

By dividing the Macaulay duration by one plus the periodic yield, it provides a direct link between interest rate moves and price fluctuations. This makes it a highly practical tool for managing interest rate risk and hedging portfolios.

For example, if a bond has a modified duration of five, a one-percent increase in yield is expected to result in a five-percent decrease in price. Like Macaulay duration, it is a linear approximation and does not account for the curvature effect, which is why convexity is often added to the analysis.

It is a standard industry metric for quantifying the impact of yield curve shifts on asset values. By using modified duration, investors can easily calculate the hedge ratio needed to neutralize their exposure to interest rate changes.

It is a essential component of the professional fixed-income toolkit.