Bond Duration Convexity calculations for US Treasuries

Feb 28, 2013 by Jawwad Farid in Asset Liability Management

Convexity & Duration calculator for US Treasury Bills, Notes and Bonds.
To demonstrate how Duration and Convexity are calculated for specific US Treasuries we select
instruments from recent US Treasury bill, note and bond auctions. Please note that we are
determining these metrics (Convexity & Duration) at issue. We will calculate Macaulay,
Modified and Effective Duration as well as Convexity for the selected Treasury issues.
You can use the approach to build your own Excel calculator.

You may first want to review our course on Duration & Convexity to become familiar with the
formulas & mechanics of the calculations before proceeding.

Bond Duration Calculation for US T-Bills

Prices & Yields

According to the Federal Reserve Bank of New York, T-Bills are quoted at a discount from face
value, with the discount expressed as an annual rate based on a 360-day year. The price (per

$100) at issue date therefore is calculated as 100*(1-T/360*0.14%) where T is the number of

days between the maturity date and the issue date, in this case 364 days.
So we have 100/(1-364/360*0.14%) = 99.858444

Bond duration convexity calculations

As you can see this tallies with the price mentioned in the auction results.
The investment rate is the coupon equivalent yield. This yield is the annualized percentage return
that the purchaser will receive if the note is purchased on the day of the quotation at the ask price
and held until maturity. Given the redemption value of the bill is $100, and the ask price is
99.858444 the coupon equivalent yield (i%) is calculated as:
99.858444*(1+i%*364/365) = 100
Therefore i% = (100/99.858444-1)*365/364 = 0.142%

Bond duration convexity calculations

Macaulay Duration
Macaulay Duration is the weighted average time to maturity where the weights are the present
values of future cash flows. In the case of a T-Bill there is only one cash flow that is due on the
maturity date, the present value of this cash flow on the issue date therefore is equal to the price
of the T-Bill. Hence the Macaulay Duration for a T-Bill will be equal to the time to maturity
(expressed in years), in this instance 364/365 =0.9973.

The same result for Macaulay Duration may be obtained using the EXCELs DURATION
function with settlement date = issue date = 10-Jan-2013, maturity date = 9-Jan-2014, Rate = 0%
(as bills are zero coupon instruments), Yield = 0.142%, frequency = 1 and basis (day count
convention) =3 (i.e. Actual/365).

Modified Duration
Modified Duration may be obtained by making an adjustment to Macaulay Duration. In
particular Modified Duration = Macaulay Duration/(1+yield %/frequency) = 0.9973/
(1+0.142%/1) = 0.99584.

Again, the result may be obtained directly in EXCEL using the function MDURATION with
settlement date = issue date = 10-Jan-2013, maturity date = 9-Jan-2014, Rate = 0% (as bills are
zero coupon instruments), Yield = 0.142%, frequency = 1 and basis (day count convention) =3
(i.e. Actual/365).

Effective Bond Duration

Effective Duration is a measure of the interest rate sensitivity of the price of the instrument to
small changes in the interests. It is given by:
(P P+)/(2*P0*(absolute change in yield%))
where P is the price of the bill if the yield rate were to decline by a small amount (in our
example 0.10%) and P+ is the price of the bill if the yield rate were to increase by the same small
amount. P0 is the price of the bill at the current yield%. The current yield as mentioned earlier is
0.142% so given the % change in yields, the increased yield is 0.242% and the decreased yield is
0.042%.
The prices have been calculated using the coupon equivalent yields as follows:

100/(1+i%*364/365).

With effective duration calculated as given in the image below:

The effective duration therefore works out to 0.9958.

Convexity
Duration ignores the curvature of the price-yield function. It may therefore over- or underestimate the price change when interest rates change because it presumes that prices will be
impacted by the same extent whether interest rates increase or decrease. The convexity measure
aims to correct for this deficiency in the duration metric. Effective convexity is calculated as
follows:

(P + P+-2*P0)/(2*P0*(absolute change in yield%^2)) , where prices are defined as mentioned

earlier for effective duration.

The effective convexity therefore works out to 0.9917.

% Change is Price
What is the % change in price if interest rates increase by 0.10%? The answer is given by the
following formula:
-Duration * change in yield% + Convexity *(change in yield%^2)
Note in this instance we are taking the actual change in yield and not its absolute value.

An increase of 0.10% in the yield rate would cause prices to decline by 0.09949%. While a
0.10% decline in yields would result in a price increase of 0.09968%.

Bond Duration, convexity calculation for Treasury Notes

Bonds

The price for the 5-year Note determined above may be calculated in EXCEL using the PRICE
function with settlement date = issue date = 31-Jan-2013, maturity date = 31-Jan-2018, Rate =
0.875%, Yield =0.889%, Frequency =2 (for semiannual coupon payments) and day count
convention =1 (Actual/Actual).
The price may also be determined using first principles, by stripping each future coupon and
principal cash flow and discounting each of these to the issue date using the yield rate.
The same methodology mentioned for notes in this section may be used to determine the price,
duration, convexity & sensitivity for the 30-year Treasury Bond.

According to the Federal Reserve Bank of New York, note and bond prices are quoted in
dollars and fractions of a dollar [where the] fraction used for Treasury security prices is
1/32.
To convert these prices into the quoting convention we may use the following approach:

Where, 99.298138 in quoting convention is equivalent to $99.931681 (=99+29.8138/32).

Macaulay Duration
Notes and Bonds have periodic coupon payments. To calculate the Macaulay duration first strip
each payment and calculate its present value to the settlement date (in this case the issue date).
Multiply the each present value with its corresponding time to maturity in years. Sum the derived
products and divide this sum by the total of the present values (i.e. the price). The resulting
figure is the Macaulay Duration the weighted average time to maturity (in years) with weights
as these present values.

Macaulay Duration using EXCELs DURATION function will also give the same answer without
requiring the user to calculate the present values of each cash flow [with settlement date = issue
date = 31-Jan-2013, maturity date = 31-01-2018, Rate = 0.875%, Yield =0.889%, Frequency =2
and day count convention =1 (Actual/Actual)].
The methodologies for Modified Duration, Effective Duration and % change in price (sensitivity)
are similar to what was done for bills. For Modified Duration calculated using EXCEL
MDURATION function use settlement date = issue date = 31-Jan-2013, maturity date = 31-012018, Rate = 0.875%, Yield =0.889%, Frequency =2 and day count convention =1
(Actual/Actual).

Download the Duration and Convexity for US Treasury Bill, Note and Bond EXCEL file for
free!