Durations Explained.

[His mom]

The use of the concept of Duration appears to be context dependent in this program. Here’s what I *think* duration means:
Effective Duration: Change in bond price for 100 bp change in underlying interest rates
Modified Duraiton: Change in bond price for 100 bp change assuming cashflows do not change.
Key Rate Duration: Change in bond price for a specific change in future interest rates (IE only 10 year rates go up)
Duration: CFA assumes you aren’t painfully confused by simply referring to time as duration. Occaisionally. With little context.
Two questions:
1- When matching assets to liabilities, the duration of the bonds must exceed the liabilities. TIME duration, right?
2- With swaps…..when pay floating has positive duration, and pay fixed has negative duration, which flavor duration are they referring to, effective?

 

[S2000magician]

His mom wrote:The use of the concept of Duration appears to be context dependent in this program. Here’s what I *think* duration means:

This article I wrote may help dispel some of your doubts: http://financialexamhelp123.com/macaulay-duration-modified-duration-and-....

His mom wrote:Effective Duration: Change in bond price for 100 bp change in underlying interest rates
Modified Duration: Change in bond price for 100 bp change assuming cash flows do not change.
Key Rate Duration: Change in bond price for a specific change in future interest rates (IE only 10 year rates go up)

Remember that all of these durations measure the percent change in the bond’s price, not the dollar change in price.

His mom wrote:Duration: CFA assumes you aren’t painfully confused by simply referring to time as duration. Occasionally. With little context.

They’re quite cavalier about it.

His mom wrote:Two questions:
1- When matching assets to liabilities, the duration of the bonds must exceed the liabilities. TIME duration, right?

Yes: Macaulay duration. CFA Institute mixes effective duration (on the bonds) with Macaulay duration (on the liabilities). Improperly, in my opinion.

His mom wrote:2- With swaps…..when pay floating has positive duration, and pay fixed has negative duration, which flavor duration are they referring to, effective?

Yes: effective duration. It’s the only flavor of duration that makes sense for a floating rate bond (or, indeed, any bond with uncertain cash flows).

 

[His mom]

Bang on. Thanks S2000 Magician.
I’m glad to see that this is confusing for others, and that you have found a solution.

 

[S2000magician]

His mom wrote:Bang on.

Thanks.

His mom wrote:Thanks S2000 Magician.

My pleasure.

His mom wrote:I’m glad to see that this is confusing for others …

Most of me wishes that it weren’t (but part of me is glad because it gives me something to do).

His mom wrote:… and that you have found a solution.

I’m happy to be of some small help.