Question

"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."

Answer 1

Answer: overestimate; underestimate

Step-by-step explanation:

Here are the options to the question

a. underestimate; underestimate

b. overestimate; overestimate

c. underestimate; overestimate

d. overestimate; underestimate

The modified duration determines changes in a bond's duration and the price for every percentage change in yield to maturity. It expresses the measurable change in value of a security in the response to change in interest rates. It follows the concept that states that interest rates and the prices of bond move in opposite directions.

When investors rely on the modified duration in order to estimate the percentage change in price of a bond, investors overestimate the price decline that is associated with an increase in interest rates and underestimate the price increase that is associated with a decrease in rates.