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Duration
Duration of a security with price P is the (negative of the)
percent sensitivity of the price P to a small parallel shift in the
level of interest rates.
Let r(t, T) be the continuously compounded term structure of
interest rates at time t.
Due to uniform shift of size dr across rates, the price of the
security moves by dP
The duration of the asset is then defined as:
1 dP
Duration = D
P dr
Duration
Given the duration DP of a security with price P, a uniform
change in the level of interest rates brings about a change in
the value of:
= - Rs.100,000
dPZ
100 (T t ) e r (T t )
dr
= -(T-t)*Pz (t,T)
D
1 dP
P dr
= T-t
(Time to maturity)
Example
The duration of a 5-year STRIPS is 5.
This implies that a one basis point increase in interest
rates decreases the value of the portfolio by 5 basis
points.
A portfolio of Rs.100 million will experience a decline of
approximately Rs.50,000.
Duration of a Portfolio
Duration of a portfolio is a weighted average of the duration
of assets, where the weights correspond to the percentage of
the portfolio invested in a given security
The duration of a portfolio of n securities is given by
n
DW wi Di
i 1
Duration of a Portfolio
An example:
A bond portfolio manager has Rs.100 million
invested in 5-year STRIPS and Rs.200 million
invested in 10-year STRIPS
The impact of a one basis point parallel shift of
the term structure on the value of the portfolio
can be found by computing the duration of the
portfolio
The 5-year and 10-year strips have duration of 5
and 10, respectively
The total portfolio value is Rs.300 million
Duration of a Portfolio
Duration of the portfolio:
100
200
5 10 8.3
300
300
Therefore, a one basis point increase in interest
rates generates a portfolio loss of Rs.249,000
Loss in portfolio value = Rs.300 million 8.3 0.01%
= Rs.249,000
i 1
i 1
DW wi Dz ,Ti wT
i i
Where
wi
c / 2 Pz 0, Ti
Pc 0, Tn
for i = 1,,n-1;
1 c / 2 Pz 0, Tn
wn
Pc 0, Tn
PFR t , T Z t , Ti 1 100 1 r2 Ti / 2
DFR
dPFR
1
PFR t , T dr
dZ t , Ti 1
1
100 1 r2 Ti / 2
PFR t , T
dr
1
Ti 1 t Z t , Ti 1 100 1 r2 Ti / 2
PFR t , T
Ti 1 t
Dollar Duration
Duration implicitly assumes that the security, or the portfolio,
has non-zero value.
In many cases involving no arbitrage (Long-Short) strategies,
the security or the portfolio may have a value exactly equal to
zero.
In such cases and for certain swaps, we calculate the dollar
duration
dP
$
Dollar Duration of a security is defined by
DP
dr
For a non-zero valued security: D$P = P DP
For a portfolio of n securities (Dn$W) with Ni units of security i
D Ni D
$
W
i 1
$
i
D dr
$
P