Fixed income instrument

chandniwadhwani92
Finance Junkie
Posts: 166
Joined: Mon Oct 06, 2014 7:36 am

Fixed income instrument

Postby chandniwadhwani92 » Tue Oct 07, 2014 3:18 pm

In schweser it is given that modified duration is a linear extimate of relation between bond price and ytm??????
What does linear extimate means?
What is an exact difference between modified duration and approximate modified duration?????

edupristine
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Posts: 722
Joined: Wed Apr 09, 2014 6:28 am

Fixed income instrument

Postby edupristine » Fri Oct 10, 2014 5:11 am

When it is said that modified duration is a linear approximation of bond price changes for small changes in market yields, it means that the price changes are a linear function of the changes in yields.
This is as depicted in the below formula:
Approximate change in bond price = - (Modified Duration)* (change in yields)

However in real time scenarios, price changes are not linear, but a curvilinear or complex function.

Modified duration can be calculated as Macaulay Duration/ (1+YTM).
Whereas approx.. modified duration is calculated by directly using bond values for a same percentage point increase or decrease in YTM.


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