What is the difference between effective duration and modified duration?

While Effective Duration is a more complete measure of a bond’s sensitivity to interest rate movements versus the Macauley or Modified Duration measures, it still falls short because it is a linear approximation for small changes in yield; that is, it assumes that duration stays the same along the yield curve.

What is effective duration CFA?

The effective duration is defined as the sensitivity of the price of a bond against a change in a benchmark yield curve.

Is effective duration expressed in years?

Duration is measured in years. Generally, the higher the duration of a bond or a bond fund (meaning the longer you need to wait for the payment of coupons and return of principal), the more its price will drop as interest rates rise.

What does a negative effective duration mean?

A situation in which the price of a bond or other debt security moves in the same direction of interest rates. That is, negative duration occurs when the bond prices go up along with interest rates and vice versa. Negative duration means that the bank’s equity is negative.

What is the difference between duration and Macaulay duration?

The Macaulay duration calculates the weighted average time before a bondholder would receive the bond’s cash flows. Conversely, the modified duration measures the price sensitivity of a bond when there is a change in the yield to maturity.

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 one sided up duration?

The “up” and “down” refers to the interest rates, not bond prices. So to say that callable bonds have higher “up” duration means that when interest rates go up, prices fall, and the bond is less likely to be called (and more likely to run through maturity –> higher duration).

What is duration formula?

What is the Duration Formula? 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 duration in investment?

Duration can measure how long it takes, in years, for an investor to be repaid the bond’s price by the bond’s total cash flows. Duration can also measure the sensitivity of a bond’s or fixed income portfolio’s price to changes in interest rates.

What is the difference between duration and spread duration?

Spread duration is of interest only for risky bonds, and key-rate duration is generally of interest only for portfolios of bonds.

What’s the difference between PV01 and DV01 of a bond?

Seem to be confused over the difference between PV01 of a bond and DV01 of the bond. PV01, also known as the basis point value (BPV), specifies how much the price of an instrument changes if the interest rate changes by 1 basis point (0.01%). DV01 is the dollar value of one basis point change in the instrument. Is my explanation correct?

What is the formula for modified duration?

The formula for the modified duration is the value of the Macaulay duration divided by 1, plus the yield to maturity, divided by the number of coupon periods per year. The modified duration determines the changes in a bond’s duration and price for each percentage change in the yield to maturity.

What is the duration equation?

Formula: Duration = Work / assignment Units. For instance: 5 days = 40 hours / 100%. Duration is the length of working time between the start and finish of a task. MS Project bases the calculation of a task’s duration on the amount of work and the amount of resource units assigned to it.

How do you calculate bond duration?

Duration of a Bond. You can use different methods to figure out a bond’s duration. One method is the Macaulay Duration formula, which can be looked up on the Internet. The Macaulay formula states that duration equals the current value of the bond’s cash flow, weighted by the length of time until receipt and divided by the bond’s current value.