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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Investing in Fixed Income Securities

Which of the following best describes the relationship between a bond's modified duration and its price sensitivity to interest rates?

A bond with modified duration of 5 will fall roughly 5% in price if yields rise by one percentage point. Modified duration estimates percentage price sensitivity to yield changes, so higher duration means greater interest rate risk, not credit risk.

  1. AA higher modified duration means a smaller percentage price change for a given yield change
  2. BModified duration is unrelated to coupon rate and maturity
  3. CA bond with modified duration of 5 will fall approximately 5% in price for a 1 percentage point rise in yieldCorrect
  4. DModified duration measures credit risk of the issuer

Explanation

Modified duration approximates the percentage price change for a 1% (100 bps) change in yield, in the opposite direction. So a duration of 5 implies about a 5% fall when yields rise by 1 percentage point. Higher duration means greater, not smaller, sensitivity, and duration is affected by coupon and maturity; it does not measure credit risk.

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