Duration : Macaulay, Modified, or Effective ?

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Asuka

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Which “duration” does it mean if it is not specifically mentioned ? Macaulay, Modified, or Effective ?
 
I believe that there is only one duration in the CFA curriculum - effective duration.
 
Yup: effective duration.
(I’d submit, however, that understanding Macaulay duration and modified duration is quite useful, and will improve your understanding of effective duration.)
 
Is Macaulay duration the one that takes the weighted average of the cash flows and then discounts them? That’s how I learned what duration was, and I think it’s easier to understand that way.
 
Greenman72 wrote:Is Macaulay duration the one that takes the weighted average of the cash flows and then discounts them? That’s how I learned what duration was, and I think it’s easier to understand that way.
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Close. It’s weighted average time-to-receipt-of-cash-flow, so the (PV of the) cash flows are the weights, multiplied by the time-to-receipt. I’m sure that’s what you were thinking.
It’s a great visualization, and it’s easy to see the effect of changing maturity and coupon, and somewhat easy to see the effect of changing YTM. A lot easier than for modified or effective duration.
I think that CFA Institute’s decision to drop Macaulay duration from the curriculum was … I’ll be charitable here … short-sighted. I was thinking of another adjective.
 
Greenman72 wrote:
I believe that there is only one duration in the CFA curriculum - effective duration.
Click to expand...
Macaulay Duration and Modified Duration are stated in Reading 58 (Vol 5 of CFAI curriculum).
 
Asuka wrote:
Greenman72 wrote:I believe that there is only one duration in the CFA curriculum - effective duration.
Click to expand...
Macaulay Duration and Modified Duration are stated in Reading 58 (Vol 5 of CFAI curriculum).
Click to expand...
Yup: LOS 58.f; it says to distinguish and explain them.
When CFA Institute says “duration”, they mean “effective duration”.
I don’t know if CFA Institute says that Macaulay duration is a measure of interest rate sensitivity or not. It isn’t intended to be, and shouldn’t be used as such a measure. Modified duration is a measure of interest rate sensitivity … if the cash flows don’t change. Effective duration is a measure of interest rate sensitivity whether cash flows change or not.
By the way, all duration measures have time as their units: usually years. Unfortunately, CFA Institute has dropped the units, and writes things like, “the duration of this bond is 4.5.” What they mean is that it’s 4.5 years, whether they’re talking about Macaulay duration, modified duration, or effective duration.
 
For the Dec 2013 and Dec 2014 L1 materials, LOS 55B (Study Session 16) says “define, calculate, and interpret Macaulay, modified, and effective durations;”, so it’s still in there. Add I agree - understanding Macauley duration goes a long way towards understanding effective duration.
The way I’ve always taught durationis by first establishing that the FUTURE value N years hence changes by about (as an example) N% for every 1% change in the discount rate. Form there, they see that the the PV of mthe future cash flow behaves similarly. And from there, it’s a short hop to MAcauley Duration, and an even shorter hop from Macauley to effective duration.
Of course, Macauley always makes me think of Macallan’s, so I end up celebrating the topic later in the day appropriately (another reason why I’m glad Macauley is still in the curriculum - I’m teachin it shortly).
 
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