On the Calculation of Bond Duration and Convexity

By analyzing and comparing the difference on concept and calculation between macaulay duration and modified duration of bond, this paper points out that it is modified duration that plays an important role in bond or bond portfolio risk management, for large yield changes convexity should be added to improve the performance of the modified duration. Because coupon bond or bond portfolio can be decomposed into a series of zero-coupon bond, we propose a methodology to calculate the modified duration and convexity of coupon bond or bond portfolio based on the principle of that portfolio return is the weighted average return of various components in that portfolio. An example is also involved for illustration of calculating process of modified duration and convexity and their application