Modified duration measures a bond’s price sensitivity to interest rate changes, expressed as the percentage price change for a 1% change in yield. This risk metric helps bond traders and portfolio managers assess and manage interest rate risk exposure. Modified duration accounts for the inverse relationship between bond prices and interest rates.

Understanding modified duration helps optimize bond portfolio construction and hedging strategies. Higher duration bonds exhibit greater price volatility from interest rate changes, while shorter duration bonds provide more stability. Modified duration calculations consider coupon rates, time to maturity, and current yield levels to provide accurate sensitivity measures.

Real-world example: A 10-year Treasury bond with modified duration of 8.5 would decrease approximately 8.5% in price if interest rates increased by 1%, helping portfolio managers assess interest rate risk and hedge exposure appropriately.