12 June 2020

Duration

Another word for duration could be the average life of a bond

by John Royden

Head of Research


Technically, duration is the weighted average length of time to the receipt of a bond’s benefits (coupons and redemption value) with the weightings being driven by the present value of the benefits involved. So the first year’s coupon of £5 only reduces the average life of the bond by a small amount. This approach is called Macaulay Duration.

The longer the duration of a bond, the more sensitive it is to changes in interest rates. Lower coupons and lower yields lengthen duration, which then begs the question: “What is the exact relationship to changes in interest rates and changes in the value of a bond?”

To answer that, we use what is called Modified Duration which calculates the percentage change in the price of a bond arising from a 1% change in yields. It is calculated by taking the Macaulay Duration and dividing it by (1 + [Gross Redemption Yield]).

Take a one year zero coupon bond and a three year zero coupon bond when interest rates are 2%, by way of example. The one year has a Modified Duration of 0.98% whereas the three year is at 2.94%. So, if interest rates rise by 1%, the three year bond will fall in price by 2.94%. 

Managing your wealth

Managing your wealth


Also in this issue

There have been many financial, social and political crises and wars over the years, including in the 1950s, ‘60s and to a lesser extent the ‘70s, when some appalling flu epidemics struck the Western…

Previously a sprawling healthcare conglomerate, Cooper Companies has now found its focus within the speciality contact lens and women’s healthcare markets.

Summer Issue Thirty One