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CMA Final · Risk Management in Banking and Insurance · Interest Rate Risk Management

A bond has a modified duration of 4.5 and is trading at a price of ₹1,000. Using the duration approximation, the price change for a rise in yield of 40 basis points is closest to:

The price falls by about ₹18. Percentage price change equals negative modified duration times the yield change, so 4.5 multiplied by 0.40% gives 1.8%, which is ₹18 on a ₹1,000 bond. Prices move inversely to yields, so a yield rise reduces the price.

  1. ADecrease of ₹18Correct
  2. BIncrease of ₹18
  3. CDecrease of ₹1.80
  4. DDecrease of ₹45

Explanation

Percentage price change = -Modified duration x change in yield = -4.5 x 0.40% = -1.8%. On ₹1,000 this is a fall of ₹18. Option ₹1.80 mis-scales by a factor of ten. Option ₹45 uses a 1% change in yield instead of 0.40%. An increase is wrong because price and yield move inversely.

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