Duration

The exam loves to make you pick the right duration for the right bond: when an item mentions a callable or putable bond, the only valid measure is effective duration, because the embedded option lets cash flows change with yield — choosing Macaulay or modified there is the planted trap. A classic computation gives you Macaulay and asks for modified duration: divide by (1 + periodic yield), so modified is always slightly smaller than Macaulay (under discrete compounding). Another favorite: a zero-coupon bond’s Macaulay duration equals its maturity, while any coupon bond’s duration is shorter.

Don’t confuse duration with maturity — maturity is a fixed calendar date, while duration weights all cash flows, so a higher coupon and a higher yield both lower duration. The other classic error is treating the linear duration estimate as exact; for large yield jumps it overstates the price drop (and understates the gain), which is precisely why convexity corrects it. Memory hook: duration is the slope, convexity is the bend — slope alone always misses the curve.