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Understanding Bond Duration Calculations

Duration is not the same as maturity. Duration is the average time to receive the bond's cash flows, weighted by the size of the cash flows. It indicates the sensitivity of a bond's price to changes in interest rates. A coupon bond's duration is typically less than its maturity because it makes regular coupon payments before maturity, while a zero coupon bond's duration equals its maturity since it only pays at maturity.

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Mohammad Al Akoum
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7 views8 pages

Understanding Bond Duration Calculations

Duration is not the same as maturity. Duration is the average time to receive the bond's cash flows, weighted by the size of the cash flows. It indicates the sensitivity of a bond's price to changes in interest rates. A coupon bond's duration is typically less than its maturity because it makes regular coupon payments before maturity, while a zero coupon bond's duration equals its maturity since it only pays at maturity.

Uploaded by

Mohammad Al Akoum
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd

Chapter 3

Calculating Duration
Duration is not maturity
• Duration is known as effective maturity.
• Duration is the average lifetime of a debt security’s stream of
payments (or weighted average of the maturities of the cash
payments)
• A coupon bond makes substantial payments before the maturity date.
• A zero coupon bond makes all its payments at maturity.
ISSUANCE
MATURITY
Consider a $1000, 4 year, 10% coupon bond.
0 1 2 3 4

-$1000 100 100 100 1100

• Price: $1000
• Face Value: $1000
• Coupon rate: 10%
Calculating Duration i =10%,
10-Year 10% Coupon Bond
Table 3.3 Calculating Duration on a $1,000 Ten-Year 10% Coupon Bond
When Its Interest Rate Is 10%

• 
Calculating Duration i =20%,
10-Year 10% Coupon Bond
Table 3.4 Calculating Duration on a $1,000 Ten-Year 10% Coupon Bond
When Its Interest Rate Is 20%

• 
Formula for Duration

• total PV

• Key facts about duration


1. All else equal, when the maturity of a bond rises, the
duration rises as well.
2. All else equal, when interest rates rise, the duration of a
coupon bond will fall.
3. All else equal, when the coupon rate rises, the duration
decreases.
Duration and Interest-Rate Risk

initial • ∆P: change in price


• DUR: duration
• ∆i: change in interest
• If for example interest rates increase from 10% to
rates
11%: • iinitial : starting interest
rate

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