What is the Difference Between Duration and Modified Duration?

Duration and modified duration are both measures used to assess how a bond's price will react to changes in interest rates. However, they provide different insights into the bond's price sensitivity to interest rate changes. The key differences between duration and modified duration are:

1. Measurement Units: Macaulay duration measures the weighted average time until the bond's cash flows are received, expressed in years. In contrast, modified duration measures the percentage change in a bond's price for a 1% change in interest rates.
2. Yield to Maturity: Modified duration takes into account the bond's yield to maturity (YTM) and coupon payments, while Macaulay duration does not. This makes modified duration a more accurate measure of a bond's price sensitivity to interest rate changes.
3. Practicality: Modified duration is considered a more practical measure of price sensitivity for bond investors, as it provides a percentage change in the bond's price per basis point. This makes it easier for investors to understand the impact of interest rate changes on a bond's price.

In summary, while both duration and modified duration are useful for evaluating a bond's price sensitivity to interest rate changes, they provide different insights. Macaulay duration focuses on the weighted average time to receive all the bond's cash flows, while modified duration measures the percentage change in a bond's price for a 1% change in interest rates, taking into account the bond's yield and coupon payments.

Comparative Table: Duration vs Modified Duration

The key differences between duration and modified duration are:

Both duration and modified duration are important for understanding a bond's price sensitivity to interest rate changes and can help investors make informed decisions when selecting investments. However, they provide different insights, and investors should be aware of these differences when using them to evaluate bonds.