DURATION IN BOND VALUATION

                                                        

                                             DURATION IN BOND VALUATION

Duration measures how much time is required to repay the true cost of the bond. True cost of a bond means intrinsic value of a bond (not par value. We can explain this term Duration with the help of an example:-

          

                                             Face value                               Rs 100

                                            Coupon rate                             Rs 12%

                                            Years to maturity                    5 years

                                            Redemption value                   Rs 100

                                            Yield to maturity                    15%

                                                                  

                                                       DURATION OF BOND

Year	Cash flow	Pv factor at 15%	Discounted cash flow	% of present value	Weighted average time
1	12	.870	10.44	10.44/89.93=11.61%	1*11.61%=.12
2	12	.756	9.07	9.07/89.93=10.09%	2*10.09%=.20
3	12	.658	7.90	7.90/89.93=8.78%	3*8.78%=.26
4	12	.572	6.86	6.86/89.93%=7.63%	4*7.63%=.31
5	12+100=112	.497	55.66	55.66/89.93%=61.89%	5*61.89%=3.09
		Intrinsic value	89.93	100	3.98 years

    

Here intrinsic value is 89.93 and Duration 3.98 year. From the above example it is clear duration of a bond is weighted average maturity of its cash flows stream where the weights are proportional to the present value of cash flows.