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

Explain potential and current lenders of long-term funds, Which ratios woul...

Which ratios would a potential long-term bond investor be most interested in? Explain. Potential and Current lenders of long-term funds, such as bondholders and banks, are con

Valuing a callable bond using binomial model, The process of va...

The process of valuing a callable bond is similar to that of an option-free bond, except for one thing - when the call option may be exercised b

Show market risk in systematic risks, Market risk as that portion of total ...

Market risk as that portion of total variability of return caused by the alternating Forces of bull and bear markets. When the security index moves upward haltingly for a signifi

Financial planning assignment, School of Business BUACC1521 Personal Financ...

School of Business BUACC1521 Personal Financial Planning ASSIGNMENT 1. General information As detailed in the Course Description, the assignment constitutes 30% of the tota

Explain about the debt policy, Explain about the debt policy Designing...

Explain about the debt policy Designing debt policy the debt policy of a firm is significantly influenced by the cost consideration. In designing financing policy, that is, p

The chinese pension fund system, The Chinese Pension Fund System Mainlan...

The Chinese Pension Fund System Mainland China has a rapidly aging population. This is attributable to two main factors - the one-child policy plus substantial improvements in l

Answer, Part B This case is intended to be an introduction to the various ...

Part B This case is intended to be an introduction to the various methods used in capital budgeting and looks at some of the decisions that may have to be made when evaluating pro

Explain accept-reject criteria, Q. Explain Accept-Reject Criteria? Acce...

Q. Explain Accept-Reject Criteria? Accept-Reject Criteria:- If actual ARR is elevated than the predetermined rate of return .......................Project would be accep

Capm model and financial leverage beta , 1. Capital Asset Pricing Model an...

1. Capital Asset Pricing Model and Multinational Corporations Why do some critics say the CAPM model is not appropriate in an international setting? Please explain a way that

Rating scale, Rating denote an issuer's ability to respond to adverse...

Rating denote an issuer's ability to respond to adverse changes in circumstances and economic conditions. The rating scale is generally differentiated into variou

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