Dollar Duration
What is the Dollar Duration
The dollar duration measures the dollar change in a bond's value to a change in the market interest rate. The dollar duration is utilized by professional bond fund managers as an approach to approximating the portfolio's interest rate risk.
Dollar duration is one of several unique measurements of bond's duration, As duration measures evaluate the sensitivity of a bond's price to interest rate changes, dollar duration tries to report these changes as a genuine dollar amount.
Rudiments of Dollar Duration
Dollar duration, at times called money duration or DV01, depends on a linear estimation of how a bond's value will change in response to changes in interest rates. The genuine relationship between a bond's value and interest rates isn't linear. In this manner, dollar duration is an imperfect measure of interest rate sensitivity, and it will just give an accurate calculation to small changes in interest rates.
Numerically, the dollar duration measures the change in the value of a bond portfolio for each 100 basis point change in interest rates. Dollar duration is frequently alluded to officially as DV01 (for example dollar value per 01). Keep in mind, 0.01 is equivalent to 1 percent, which is much of the time meant as 100 basis points (bps). To compute the dollar duration of a bond you really want to know its duration, the current interest rate, and the change in interest rates.
Dollar Duration = DUR x (∆i/1+ I) x P
where:
- DUR = the bond's straight duration
- ∆I = change in interest rates
- I = current interest rate; and
- P = bond price
While dollar duration alludes to an individual bond price, the sum of the weighted bond dollar durations in a portfolio is the portfolio dollar duration. Dollar duration can be applied to other fixed income products also that have prices that differ with interest rate moves.
Dollar Duration versus Other Duration Methods
Dollar duration varies from Macaulay duration and modified duration in that modified duration is a price sensitivity measure of the yield change, meaning it is a decent measure of volatility, and Macaulay duration utilizes the coupon rate and size plus the yield to maturity to evaluate the sensitivity of a bond. Dollar duration, then again, gives a straightforward dollar-amount calculation given a 1% change in rates.
Limitations of Dollar Duration
Dollar duration has its limitations. Right off the bat, since it is a negative slanting linear line and it assumes the yield curve moves in parallels the outcome is just an estimate. Nonetheless, on the off chance that you have a large bond portfolio, the estimate turns out to be to a lesser degree a limitation.
Another limitation is that the dollar duration calculation assumes the bond has fixed rates with fixed interval payments. Nonetheless, interest rates for bonds contrast in light of market conditions as well as the presentation of synthetic instruments.
Features
- Dollar duration calculations can be utilized to work out risk for some fixed income products, for example, advances, par rates, zero-coupon bonds, and so on.
- Dollar duration is utilized by bond fund managers to measure a portfolio's interest rate risk in nominal, or dollar-amount terms.
- There are two principal limitations to dollar durations: it might bring about an estimation; and it assumes that bonds have fixed rates with fixed interval payments.
