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A bond is trading at a price of 100 with a yield of 8%
A bond is trading at a price of 100 with a yield of 8%. If the yield increases by 1 basis point, the price of the bond will decrease to 99.95. If the yield decreases by i basis point, the price of the bond will increase to 100.04. What is the modified duration of the bond?
Expert Solution
Approximate modified duration can be estimated using by taking the difference between the price when interest rates increase and the price when interest rates decrease divided by 2 times the product of change in yield and the base price:
Where Pd is the price after a decrease in yield, Pi is the price after an increase in yield, P0 is the base price i.e. before any increase or decrease in yield and deltaY is the change in yield.
Approximate Modified Duration = 100.04 - 99.95/2*100*0.01%
Approximate Modified Duration = 4.5
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