The lower the coupon, the greater the price volatility, since the modified duration will be higher. It can be taken as the percentage change in the PV of the cash flows for a given percentage change in the discount rate. Modified duration works well in predicting the change in value of the cash flows, but it is not wholly accurate. Modified duration is accurate for small changes, but as the changes increase it becomes less accurate. Discuss how convexity helps analyse the effects of interest rate movements.
Modified duration becomes inaccurate as interest rate changes become larger.
It overestimates the effect of changes in interest rates, more for increases in interest rates than for falls. This error is convexity. For a given change, the increase is larger than the decrease. This is due to the effect of discounting on the future cash flows. The effects of convexity can be best appreciated from a visual representation.