Question

Which of the following is true about duration and modified duration?

I. The Macaulay duration calculates the weighted average time before a bondholder would receive the bond's cash flows.
II. Modified duration measures price sensitivity of a bond to changes in YTM by adjusting duration with a factor based on current yield.
III. The value of duration and modified duration are usually very close, but duration is almost always a larger number.

a. Only I and II are true.
b. All but IV are true.
c. Only II and III are true.
d. All are true.

Answer 1

Answer:

The truth about Macaulay Duration and Modified Duration is:

d. All are true.

Explanation:

Principally, the Macaulay Duration, used mainly with immunization strategies, measures the weighted average time an investor holds a bond until the period when the present value of the bond’s cash flows equals to the initial bond amount.

On the other hand, the Modified Duration, providing a risk measure by being sensitive to interest rates, identifies the amount by which the duration changes for each percentage change in the yield and, at the same time, measures how the amount of a change in the interest rates impacts a bond's price.