Macaulay Duration

Question 1

What is expressed by the Macaulay duration of a bond?

• the time it takes
• in years
• for a bond investor to recover their initial investment
• taking into account coupon/interest payments
• and the capital repayment on redemption
• it is used as a measure of the bonds sensitivity to interest rates
• for every 1% change in int rates, bond prices will move the opposite way by the amount of the modified duration - a variation of the Macaulay duration

Answer 1

Modified duration - why is the duration of the bond a key indicator

MD = Macaulay duration
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1 + GRY

• MD of a bond estimates how much a bonds price will change if there is a change in interest rates/yields
• it quantifies the sensitivity of the bond price to changes in GRY and Price - it is a straight line with a direct linear relationship.
• if MD is 2, then for every 1% rise in yield (GRY), the price will fall by 2% (inverse relationship)
• However, due to convexity, MD will tend to underestimate rises in value and overestimate falls in value.