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
(a) The term "financial reporting" incorporates not only financial statements, but also includes other means of communicating financial and non-financial information. Financial rep

Our geologist, Rebecca Paulka, has estimated from the earlier exploration that the Malian prospects have a 30% likelihood of containing economic quantities of uranium ore, the Nige

At the end of 1922, your great grandfather (g.g.f.) established a trust fund to be used in order to help a later generation of the family obtain a university education. The ultimat

(a) The subsequent is a discussion based upon IFR Special Report in issue 1239 during the Year 1998. Danish mortgage bonds have extended been domestic investors' referred d

Q. Miller Approach of irrelevance of dividends? Discuss the Modigliani as well as Miller Approach of irrelevance of dividends. What are its drawbacks? Ans. Modigliani with M


What level of profits can you earn in a perfectly competitive market and what drives markets towards perfect competition over the long run?

What are the coupon bonds security instruments? Coupon bonds are contractual agreements by the borrowers to make regular payments (known as coupons or interest) until a specifi

Discuss the advantages and disadvantages of the gold standard. Answer:  The benefits of the gold standard include: (I) as the supply of gold is restricted, countries cannot compr

Q. Describes the Gordons dividend model? Gordon's Model: - Gordon's model is one more theory which contends that dividend policy is relevant for the value of the firm. Alternat