Durations

Question 1

What is Macaulay Duration?

Answer 1

The weighted average time (in years) to receive a bond’s cash flows. A measure of time, not sensitivity.

Question 2

How is Macaulay Duration used in portfolio management?

Answer 2

Duration management shortens or lengthens Macaulay duration to adjust a portfolio’s exposure to interest rate changes (anticipating rising or falling rates).

Question 3

What is Modified Duration (ModDur)?

Answer 3

A measure of the price sensitivity of a bond to changes in yield. Approximate % price change for a 100 bps (1%) change in yield.

Question 4

When do we use Modified Duration?

Answer 4

For bonds with no embedded options to measure how much the bond price will change with interest rate changes.

Question 5

What is Effective Duration (EffDur)?

Answer 5

A measure of the price sensitivity of a bond with embedded options to changes in benchmark yield curves.

Question 6

When do we use Effective Duration?

Answer 6

For bonds with embedded options (callable, putable, MBS) since cash flows are uncertain and depend on interest rate movements

Question 7

Which duration is a measure of time?

Answer 7

Macaulay Duration.

Question 8

Which durations are measures of sensitivity?

Answer 8

Modified Duration and Effective Duration

Question 9

Why wouldn’t we say “shorten Modified Duration”?

Answer 9

Because Modified Duration is a sensitivity, not a time measure. We instead speak of shortening Macaulay Duration.