If investors rely strictly on modified duration to estimate the percentage change in the price of a bond, they will tend to ____ the price decline associated with an increase in rates and ____ the price increase associated with a decrease in rates.

Question

Quizplus · Accepted Answer

Modified duration is a linear approximation of price changes, which tends to overestimate the price decline when rates increase and underestimate the price increase when rates decrease due to the convexity of the bond price-yield curve.

If Investors Rely Strictly on Modified Duration to Estimate the Percentage