CFA Practice Question
For small changes in yields, prices of option-free bonds vary ______ with modified duration.
A. logarithmically with modified duration.
B. exponentially with modified duration.
C. proportionally with modified duration.
Explanation: The relationship between price and modified duration is given by % P = (- D) x (*i), where %P is the percent change in the price of the bond, D is the modified duration of the bond, and *i is the yield change in basis points divided by 100. It has been shown that price movements of option-free bonds will vary proportionally with modified duration for small changes in yields. Specifically, an estimate of the percentage change in bond price equals the change in yield times modified duration. Note: Modified duration is always a negative value for a noncallable bond because of the inverse relationship between yield changes and bond price changes.
User Contributed Comments 3
| User | Comment |
|---|---|
| fanfare | The question is about "price", not "proportional change in price". |
| steved333 | Uh, yeah, but the price change is proportional to the modified duration. And the McCauley duration. And the duration. Any way you slice it, the behavior is proportional to it. |
| jpducros | I'd like to see the same question with convexity ;-) |