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Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition by Youssef F. Bissada, Jean Dermine

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Duration

For many years, specialists used the maturity of an asset as an indicator of interest rate risk. For example, the value of a 30-year fixed-rate bond will be more sensitive to interest rates than the value of a one-year-to-maturity bond. However, they have realized that maturity only provides information on the timing of the very last cash flow to come. It does not take into account the cash flows received earlier (such as interest payments). This is precisely what duration does. It is an average maturity that also takes into account the cash flows received in the early life of the asset.

Example

10% coupon, three-year-to-maturity bond. Price is equal to 95.2 for an interest rate curve of 12%.

Year 0Year 1Year 2Year 3Current rate
95.2 ...

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