FM: Use duration as an approximation, then check its limits
Modified duration approximates percentage price sensitivity to a small yield change. It is not a promised exact price change, and Macaulay duration cannot be inserted without the appropriate conversion. Convexity and changing cash flows can matter.
Worked example or practice scenario
For a two-year zero-coupon bond at effective yield 5%, Macaulay duration is 2 and modified duration is 2/1.05. A +.01 yield change gives an approximate −1.9048% price change. The exact ratio is (1.05/1.06)², about −1.8778%.
Try this next
Compare the approximation with exact repricing for a larger move. Explain the growing discrepancy rather than adjusting duration to force a match. For cash flows with options, identify what could change as yields move.
Reading sources
ActNet editorial guide · October 1, 2026 · Original illustrative examples.