Interpretations of duration, Financial Management

Assignment Help:

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.


Related Discussions:- Interpretations of duration

Nominal interest rate, You are considering an investment in a 40-year secur...

You are considering an investment in a 40-year security. The security will pay $25 a year at the end of each of the first 3 years. The security will then pay $30 a year at the end

Explain the costs and benefits of being a remote island, Problem: 1.1 C...

Problem: 1.1 Clearly explain the costs and benefits of being a small and remote island or a ministate economy. 1.2 Over the years, the role of government has been defined al

Leverage, ABC Ltd. Produces electronic components with a selling price per ...

ABC Ltd. Produces electronic components with a selling price per of Rs.100. Fixed cost amount to Rs.2,00,000/- 5000 units are produced and sold each year. Annua

calculate the value of the bond, a.) A bond of Rs. 1000 value carries a co...

a.) A bond of Rs. 1000 value carries a coupon rate of 10% and has a maturity period of 6 years. Interest is payable semi-annually. If the required rate of return is 12%, calculate

Define the finance function, Q. Define the finance function? Is it a risk-r...

Q. Define the finance function? Is it a risk-return trade off? What is the basic role of a modern financial manager? What is the basic importance of finance function in the mana

Describe market value weights, Q. Describe Market Value Weights? Market...

Q. Describe Market Value Weights? Market Value Weights: - As per market worth scheme of weighting the weights to dissimilar sources of finance are assigned on the basis of thei

Graduated-payment mortgages (gpms), The payments on GPMs unlike the p...

The payments on GPMs unlike the payments on traditional mortgages are not equal. The payments under GPMs start at a relatively low level and rise for a specified

What is the benefits of divestment, What is the Benefits of divestment ...

What is the Benefits of divestment ¸ Releases cash tied up to finance more promising opportunities. ¸ Reduces diversification and complexity of a group in case of a demerger

Types of working capital, TYPES OF WORKING CAPITAL Working capital can ...

TYPES OF WORKING CAPITAL Working capital can be split up into two categories on the basis of time. They are Permanent Working Capital and Temporary or Variable Working capital

Bse-500 and sectoral indices, BSE-500 and Sectoral Indices On August 9,...

BSE-500 and Sectoral Indices On August 9, 1999, another new index was introduced in the market which was based on the data of 500 companies and designated as BSE-500 index. It

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd