How is Modified Duration calculated?

Modified Duration is a measure that indicates the sensitivity of a bond's price to changes in interest rates. It is derived from Macaulay Duration, which is a weighted average time to receive the bond's cash flows.

The correct approach to calculate Modified Duration is to take the Macaulay Duration and divide it by (1 + yield/n), where 'n' refers to the number of compounding periods per year. This adjustment accounts for the bond's yield and allows Modified Duration to reflect the impact of interest rate changes on bond prices more accurately.

In essence, Modified Duration provides investors with a better understanding of how much the price of a bond is expected to change for a percentage change in yield, enhancing the bond's interest rate risk assessment. The calculation you selected specifically addresses how to adjust the Macaulay Duration to yield the Modified Duration, capturing the sensitivity concerning current interest rates.