Effective duration can be estimated using modified duration if the bond with embedded options behaves like an option-free bond. This behavior occurs when exercise of the embedded option would offer the investor no benefit. As such, the security's cash flows cannot be expected to change given a change in yield. For example, if existing interest rates were 10% and a callable bond were paying a coupon of 6%, the callable bond would behave like an option-free bond because it would not optimal for the company to call the bonds and re-issue them at a higher interest rate.
Investment dictionary. Academic. 2012.
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effective duration — (1) One of several methods of expressing duration. More accurate than Macaulay duration or modified duration. See convexity, duration, Macaulay duration, and modified duration (2) A synonym for empirical duration. See empirical duration. (3) A… … Financial and business terms
Effective duration — The duration calculated using the approximate duration formula for a bond with an embedded option, reflecting the expected change in the cash flow caused by the option. Measures the responsiveness of a bond s price taking into account the… … Financial and business terms
duration — A sophisticated measure of the average timing of cash flows from an asset or a liability or from an asset portfolio or a liability portfolio. Essentially, duration is a more accurate measure of maturity because it reflects the timing of cash… … Financial and business terms
duration of risk — The extent of time within which the losses covered by a policy of insurance must occur in order for the insurer to be liable. 29 Am J Rev ed Ins § 317. The period of time between the effective date of the policy and the termination of the risk by … Ballentine's law dictionary
Bond duration — Financial markets Public market Exchange Securities Bond market Fixed income Corporate bond Government bond Municipal bond … Wikipedia
key rate duration — A measure of duration that calculates effective or empirical duration by changing the market rate for one specific maturity point on the yield curve while holding all other variables constant. May be done as part of a series of calculations that… … Financial and business terms
negative duration — (1) The name for a particular relationship between changes in the price of a debt security and changes in prevailing interest rates. When a security has negative duration, its price decreases in response to a decrease in prevailing market rates.… … Financial and business terms
modified duration — Macaulay duration adjusted for compounding. The figure for Macaulay duration is divided by the sum of one plus the rate divided by the number of compounding periods per year. A more accurate measure of the weighted average time remaining until… … Financial and business terms
Empirical Duration — The calculation of a bond s duration based on historical data. Empirical duration is estimated statistically using historical market based bond prices and historical market based Treasury yields. When the historical yields change, the historical… … Investment dictionary
Macaulay duration — The weighted average term to maturity of the cash flows from the bond, where the weights are the present value of the cash flow divided by the price. The New York Times Financial Glossary The earliest form of duration measurement. Developed in… … Financial and business terms