Is Macaulay duration the same as modified duration?

The Macaulay duration calculates the weighted average time before a bondholder would receive the bond’s cash flows. Conversely, the modified duration measures the price sensitivity of a bond when there is a change in the yield to maturity.

What is the difference between Macaulay duration and effective duration?

While Effective Duration is a more complete measure of a bond’s sensitivity to interest rate movements versus the Macauley or Modified Duration measures, it still falls short because it is a linear approximation for small changes in yield; that is, it assumes that duration stays the same along the yield curve.

Is effective duration the same as modified duration?

Effective duration differs from modified duration because the latter measures the yield duration – the volatility of the interest rates in terms of the bond’s yield to maturity – while effective duration measures the curve duration, which calculates the interest rate volatility using the yield curve.

Why is the duration of a zero coupon bond equal to its maturity?

The higher a bond’s coupon, the shorter its duration, because proportionately more payment is received before final maturity. Because zero coupon bonds make no coupon payments, a zero coupon bond’s duration will be equal to its maturity.

Why is modified duration in years?

What Is Modified Duration? Modified duration is a formula that expresses the measurable change in the value of a security in response to a change in interest rates. Modified duration follows the concept that interest rates and bond prices move in opposite directions.

Why is modified duration better?

The modified duration provides a good measurement of a bond’s sensitivity to changes in interest rates. The higher the Macaulay duration of a bond, the higher the resulting modified duration and volatility to interest rate changes.

Why is modified duration not accurate?

The slope of the line is the instantaneous change in price for an infinitely small change in the yield. Modified Duration loses accuracy on larger changes in yield due to the convexity of the curve. Note that for an increase in yield, the price estimate is high. And for a decrease in yield, the price estimate is low.

Why is Macaulay duration important?

When rates rise, bond prices fall and vice versa. A bond with a longer maturity period is more sensitive to changes in interest rates than a bond with a short duration. This makes it important for an investor to know the Macaulay Duration of a fund before buying it.

What is Macaulay duration of a zero-coupon bond?

The Macaulay duration of a zero-coupon bond is equal to the time to maturity of the bond. Simply put, it is a type of fixed-income security that does not pay interest on the principal amount.

Is Macaulay duration measured in years?

Macaulay duration is the weighted average of the time to receive the cash flows from a bond. It is measured in units of years. Macaulay duration tells the weighted average time that a bond needs to be held so that the total present value of the cash flows received is equal to the current market price paid for the bond.

What does Macaulay duration indicate?

The Macaulay duration is the weighted average term to maturity of the cash flows from a bond. The weight of each cash flow is determined by dividing the present value of the cash flow by the price. Macaulay duration is frequently used by portfolio managers who use an immunization strategy.