Quick Answer: What Does Duration Mean In Finance?

What is Bond duration with example?

Duration is an approximate measure of a bond’s price sensitivity to changes in interest rates.

For example, a bond with 10 years till maturity and a 7% coupon trading at par to yield 7% has a duration of 7.355 years.

At a yield of 6% (price 107 14/32), its duration is 7.461 years..

What is duration in market risk?

Duration risk is the risk that changes in interest rates will either increase or decrease the market value of a fixed-income investment. … To measure the market price change, you can use this equation: ‘Change in Interest Rates x Duration = Change in Market Value. ‘

What does convexity mean?

Convexity is a measure of the curvature, or the degree of the curve, in the relationship between bond prices and bond yields. Convexity demonstrates how the duration of a bond changes as the interest rate changes.

Which bond has the longest duration?

zero-coupon bondA zero-coupon bond has the highest duration among the bonds of the same…

Can duration be more than maturity?

The duration of any bond that pays a coupon will be less than its maturity, because some amount of coupon payments will be received before the maturity date. … The higher a bond’s coupon, the shorter its duration, because proportionately more payment is received before final maturity.

How does YTM affect duration?

Duration is inversely related to the bond’s coupon rate. Duration is inversely related to the bond’s yield to maturity (YTM). Duration can increase or decrease given an increase in the time to maturity (but it usually increases).

What does effective duration mean?

Effective duration is a duration calculation for bonds that have embedded options. … The impact on cash flows as interest rates change is measured by effective duration. Effective duration calculates the expected price decline of a bond when interest rates rise by 1%.

What’s a duration?

Duration is how long something lasts, from beginning to end. A duration might be long, such as the duration of a lecture series, or short, as the duration of a party. The noun duration has come to mean the length of time one thing takes to be completed.

What is duration risk?

Duration risk is the name economists give to the risk associated with the sensitivity of a bond’s price to a one percent change in interest rates. The higher a bond’s duration, the greater its sensitivity to interest rates changes.

What is spread duration?

Spread duration is the sensitivity of the price of a security to changes in its credit spread. The credit spread is the difference between the yield of a security and the yield of a benchmark rate, such as a cash interest rate or government bond yield.

What is an example of duration?

Duration definitions Duration is defined as the length of time that something lasts. When a film lasts for two hours, this is an example of a time when the film has a two hour duration. Continuance or persistence in time. … Modified duration is a measure of Macaulay duration, which was named for Frederick Macaulay.

How do you use the word duration?

Duration sentence examplesOnce Howie was under, he broke a record for duration; one hour and eighteen minutes. … Nowhere in the discourses of Jesus is there a hint of a limited duration of the Messianic kingdom.More items…

Why is Bond duration important?

Duration is important to bond investors because it acts as a guide for how sensitive a bond (or bond portfolio) is to changes in interest rates. For most investors, the bond duration indicates how much the market price of a bond will change when its yield (i.e. its current rate of interest) changes.

What is average duration?

Average Duration. Duration is a time measure of a bond’s interest-rate sensitivity, based on the weighted average of the time periods over which a bond’s cash flows accrue to the bondholder. Time periods are weighted by multiplying by the present value of its cash flow divided by the bond’s price.

What is maturity duration?

What’s the Difference Between ‘Maturity’ and ‘Duration’? Each measure plays a key role in helping bond investors evaluate interest-rate risk, but duration is the more complex of the two. … A bond’s maturity is the length of time until the principal must be paid back.

How do you calculate duration in finance?

The formula for the duration is a measure of a bond’s sensitivity to changes in the interest rate, and it is calculated by dividing the sum product of discounted future cash inflow of the bond and a corresponding number of years by a sum of the discounted future cash inflow.

What is the difference between duration and maturity?

In plain English, “duration” means “length of time” while “maturity” denotes “the extent to which something is full grown.” When bond investors talk about duration it has a very specific meaning: The sensitivity of a bond’s price to changes in interest rates.

What is duration used for?

Duration and convexity are two tools used to manage the risk exposure of fixed-income investments. Duration measures the bond’s sensitivity to interest rate changes. … With coupon bonds, investors rely on a metric known as duration to measure a bond’s price sensitivity to changes in interest rates.

How is duration calculated?

The Macaulay Duration formula reflects the fact that Duration = Present value of a bond’s cash flows, weighted by the length of time to receipt, and divided by the bond’s current market value.

Is higher or lower duration better?

In general, the higher the duration, the more a bond’s price will drop as interest rates rise (and the greater the interest rate risk). As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration.

What does duration mean in exercise?

Duration is the length of time for each bout of any specific activity. Intensity is the rate of energy expenditure necessary to perform the activity to accomplish the desired function (aerobic activity) or the magnitude of the force exerted during resistance exercise (1).