So I’m going over some FI stuff and just thinking to myself. I have been studying this stuff for a while, and I have no idea what duration is. I know all these equations and all that ****, but no clue what it really _is_. I know its a representation of sensitivity to interest rate risk and all, but no really good, intuitive understanding. And why the **** is it called duration? Makes me think of maturity. Anyone else the same? Am I just terrible, and doomed to a life of subpar investment returns?
Same here. Had a big issue at L2 but made my peace at L3 now. It makes sense once you figure it as a fulcrum.
That’s a great article. It really helped me gain a better understanding as well.
Most likely.
The original idea of duration was Frederick Macaulay’s, and is named for him; it’s a weighted-average time to receipt of cash flows, where the weights are the present values of the cash flows to be received. As such, it makes sense to call it duration, and, in fact, its unit of measure is a unit of time, typically years.
Modified duration is a modification of Macaulay duration, and it measures a bond’s price sensitivity to changes in interest rates. It is properly called duration because its unit of measure, like that of Macaulay duration, is a unit of time, once again, typically years. (Note that a few . . . here’s that word again . . . years ago CFA Institute chose to drop the units of duration from its curriculum, wrongly in my humble opinion.)
Effective duration is another measure of a bond’s price sensitivity to changes in interest rates, one which allows for the possibility that changes in interest rates could lead to changes in the bond’s cash flows (e.g., in a floating-rate bond). Its unit of measure is, again, typically years. Similarly, key rate duration, spread duration, and so on are measures of a bond’s price sensitivity to changes in interest rates, and all properly have years as a unit of measure.
Too real man, too real