A bond-price sensitivity calculation
A training case gives a bond portfolio a modified duration of four years and asks for the first-order percentage price effect of a market-yield increase of half a percentage point. The exercise instructs the learner to ignore convexity, spread changes, accrued income and reinvestment during the immediate repricing comparison. A client also needs part of the portfolio for a known payment next month. One trainee treats the duration calculation as a guarantee that the price cannot move by more than the predicted amount. Another focuses only on the coupon and says a fixed-income product cannot lose market value. The adviser must produce the bounded arithmetic and distinguish market-price sensitivity from the client’s actual liquidity requirement.
1. Calculate the approximation.
Read the worked answer
The first-order percentage change is approximately −D × Δy = −4 × 0.005 = −0.02, or a 2% decline.
2. Explain its limits for the client.
Read the worked answer
It is an approximation under supplied assumptions, not a loss cap. The near-term payment requires separate consideration of liquidity, price uncertainty and suitable asset access.