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
Q. What is Allocation Registers? The object of allocation register is keep the heads of department of divisions districts and regions informed of the progress of expenditure by

Enumerate about the Turnkey operations An illustration of a turnkey business would be a franchise for example immediate brand, systems and product with exclusive territory. A t

what is the criteria for a good international financial system

A drug company has developed a new painkiller for chronic pains, although it is doubtful whether the new drug actually has any effect. The company conducts a double-blind experimen

which critically examines the benefits and risks to a company, of incorporating corporate debt into a portfolio of equity and debt.

As the CEO of PG Industries, you are hired at the pleasure of the Board of Directors, who in turn are elected by the shareholders. You are considering Project A which you are convi


What is the relationship between a bond's market price and its promised yield to maturity?  Explain. A bond's market price reckon on its yield to maturity (YTM).  When a bond h

Q. Describe about Profitability Index? Profitability Index OR (PI):- Second method of estimate a project through discounted cash flows is profitability index method. This metho

Enumerate the Securities and Investment Analysis Purchase of bonds, stocks and othersecurities involve analysis and techniques which are highly specialized. An investorshoul