Interpretations of duration, Financial Management

Duration is often referred to as the approximate percentage change in the price for a 1% change in rates. Now, we will see some other definitions or interpretations of duration.

Duration is the "First Derivative" 

Duration is also referred to as the "first derivative of the price/yield function". A derivative used in this context is obtained by differentiating a mathematical function. When a bond is written in the form of a mathematical equation, the value arrived at by differentiating the equation for the first time is known as the first derivative. While it is the correct interpretation of duration, this interpretation does not help us to understand the concept of the interest rate risk of a bond. Thus, it is an operationally meaningless interpretation. 

Duration is Some Measure of Time

When Macaulay introduced the measure duration he used it as a measure of time for a bond that was outstanding. He defined duration as the weighted average of the time to each coupon and principal payment of a bond. The drawbacks of this interpretation are:

  • The proper way to interpret a duration is as the price volatility of a zero-coupon bond with a number of years to maturity. For example, when we say that a bond has a duration of 5 years, it means that the bond has the price sensitivity to rate changes of a 5-year zero-coupon bond.

  • When we explain duration in terms of years, then it is very difficult to understand the duration of some complex securities.

Posted Date: 9/10/2012 5:18:43 AM | Location : United States







Related Discussions:- Interpretations of duration, Assignment Help, Ask Question on Interpretations of duration, Get Answer, Expert's Help, Interpretations of duration Discussions

Write discussion on Interpretations of duration
Your posts are moderated
Related Questions
Discuss the criteria for a ‘good’ international monetary system. Answer: A good international monetary system must offer (i) sufficient liquidity to the world economy, (ii)

#questioDiscuss the applicability of an operating cycle in the vegetable growing business n..

Towson Enterprises has recognized two mutually exclusive (can’t do both) projects.  The relevant cash flows and timing of those cash flows are shown in the following table.  Suppos

Q. Describes Net Income Approach to Capital Structure? Net Income Approach: - As-per to the Net Income Approach as suggested by Durand the capital structure decision is applica

Q. Formulation of Collection Policy ? Formulation of Collection Policy:- The third characteristic of the receivable management is to formulate a collection policy. Collection p

Mutual Fund Services: Financial Mutual Funds launch schemes to cater to the need of the different categories of investors. They provide special services in addition to the retu

Q. Credit Standards for Formulation of Optimum Credit Policy? Credit Standards: - Credit standards are the essential criteria set for extension of credit to customers. Decision

Expects the per capita expenditure: A township expects its population of 5,000 to grow annually at the rate of 5%. The township currently spends $300 per inhabitant, but, as t

Residual Income This is used for external reporting purposes. This term refers to the net income which is available for distribution to the firm's common stock holders. In mana

Determine the term- Time Value of Money If an individual behaves rationally, then he wouldn't equate money in hand today with same value a year from now. As a matter of fact, h