Economics Bonds Questions
The difference between a bond's duration and its modified duration lies in the way they measure the sensitivity of a bond's price to changes in interest rates.
Duration is a measure of the average time it takes for an investor to receive the bond's cash flows, including both coupon payments and the return of principal. It helps estimate the bond's price volatility in response to interest rate changes. Duration is expressed in years and provides a rough estimate of the percentage change in a bond's price for a 1% change in interest rates.
On the other hand, modified duration is a modified version of duration that takes into account the bond's yield or interest rate. It is calculated by dividing the duration by (1 + yield). Modified duration provides a more accurate estimate of the percentage change in a bond's price for a given change in yield.
In summary, duration measures the average time to receive cash flows, while modified duration adjusts for the bond's yield to provide a more precise measure of price sensitivity to changes in interest rates.