Determinants of Duration

and Bond Volatility

(Russell J. Fuller and

John W. Settle)

Presented by;
Mehraj Khan
Abdulah Khan

Introduction

The paper had discussed the concept of

Duration and Bond Volatility "as a risk
management tools

The determinants used in this paper are:

Coupon rate
Term to maturity
Yield to maturity

The author had tried to find relation of these

three factors and its affects on the bond volatility
& duration which is uses for investment strategy.

Continue
Duration is uses as an immunization strategy for
portfolio management
Volatility is uses as concept for fluctuating interest rate
in bond market
Duration is also a direct measure of volatility.
The more is the maturity, the more is duration and
hence the more volatile will be the bond.

Interest rate factor as compare to term to maturity

is more influencing in long term bond while in shortterm bond term to maturity is important factor
affecting duration & volatility.

Bond volatility is the absolute value of the

percentage change in bond price, given a change
in yield to maturity.
Duration represents a weighted average of the time
periods to maturity.
Bond price is the present value of the coupon stream
plus the principal payment at the maturity date

Methodology
Duration

and Bond price formula was used to find

the percentage changes in the value of the bond.

D
Where,
D=Duration
E= Natural log (equal to 2.718)
C=the coupon
i=the current yield to maturity,
n=the number of time periods to maturity


Different interest rate rates were examined
with different duration.
A relationship of coupon rate and
duration
Relationship between duration and term
to maturity was examined
Relation ship between yield to maturity

 Conclusion Important points

Duration and volatility are inversely related to coupon
rate - that is, the higher the coupon, the lower
duration and volatility - with most of the effect of the
coupon rate on duration occurring as the coupon
increases from 0% to 1%, and from 1% to 2%.
Thereafter, an increase in the coupon has a relatively a
small effect on duration.

For short-term bonds, term to maturity is the prim a y

factor in determining the bonds duration and
volatility.
For long-term bonds, n is relatively less important,
while the level of i is v e y important.

 For premium bonds, there is an unambiguously

positive relationship between term to maturity,
duration, and volatility. That is, for premium bonds,
the longer the term to maturity, the longer the
duration and the more volatile the bond.

For discount bonds, duration initially increases as n

increases, reaches a maximum, and then declines
as n continues to increase. This means that a shortterm discount bond can have a longer duration and
be more volatile than a long-term bond under some
conditions.

 There is a negative relationship between yield to

maturity and duration and bond volatility. The
higher the yield to maturity, the lower the bonds
duration and volatility, everything else held constant.

Finally, when all three factors are considered together,

the following results came:
1. The coupon rate appears to be the least important in
determining duration and volatility, assuming the
coupon rate is more than 2-3%.
2. For short term bonds (say, n less than 5), term to
maturity is the dominant factor and yield to maturity is
not particularly important.

3. For long-term bonds (say, n greater than l0), the

level of yield to maturity is the dominant factor, as
duration tends to level out at approximately l/i and
term to maturity is not particularly important.
4. For intermediate-term bonds, both term to maturity
and yield to maturity are important factors in
determining the bonds duration and volatility.