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NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Mutual Fund Scheme Selection

A distributor compares two debt funds for a client with a 2-year horizon. Fund P has a modified duration of 6 years and Fund Q has a modified duration of 2 years. If market yields are expected to rise by 1 percentage point, which is the best estimate of the approximate effect?

Fund P would fall about 6% and Fund Q about 2%, because the price change is roughly modified duration multiplied by the yield change. A 1 percentage point rise in yields hurts the longer-duration fund three times as much, so Q better matches a 2-year horizon.

  1. AFund P falls about 6% and Fund Q falls about 2%Correct
  2. BFund P falls about 2% and Fund Q falls about 6%
  3. CBoth funds fall by about 1%
  4. DFund P rises about 6% and Fund Q rises about 2%

Explanation

Approximate price change equals negative modified duration times the yield change. For P it is 6 x 1% = 6% fall and for Q it is 2 x 1% = 2% fall. Option B reverses the durations, and rising yields cause price falls, not rises. Q suits the 2-year horizon better.

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