My Frustration with the Word, “duration”

When I encountered the word, “duration,” in my translation assignment, I looked up the Internet to know what it means. Various sites describe duration as an estimated percentage change in a bond’s price for a 100 basis point change in interest rates. So far so good. Then those same sites say that duration is also measured in “years.” How could this be possible? Are you saying that percentage changes in prices can be expressed in the unit of time?

Totally confused, I bought Frank J. Fabozzi’s book, “Duration, Convexity, and Other Bond Risk Measures.” I am a translator, and not a bond analyst, but the concept of duration seems so fundamental in the world of fixed-income investment. In his book, he explains that people interpret duration as: 1) sensitivity of the bond price to one percent change in interest rates, 2) the first derivative of the price/yield curve, and 3) the weighted average number of years to receipt of the present value of the cash flows.

I already understand the first definition. The second definition also makes sense to me, although I am not sure how one can get an equation for a price/yield curve when coupon payments are discrete, not continuous. The third definition remains a mystery to me.

Fabozzi is clear about this. He explains that the first definition is sufficient. He then denounces the second and third definitions, by saying:

If you find that clients really understand the last two definitions better than the first, then send me a letter with the names of the clients and why they find it more useful and I will refund the cost of the book!

Oh, don’t I love reading Fabozzi’s book.

Megumi Kimoto

Kimoto Financial Translations

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