LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

LM11 Yield-Based Bond Duration Measures and Properties

1. Introduction ...........................................................................................................................................................2
2. Modified Duration ...............................................................................................................................................2
3. Money Duration and Price Value of a Basis Point ...................................................................................5
4. Properties of Duration .......................................................................................................................................7
Summary................................................................................................................................................................... 11

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

1. Introduction
This learning module covers:
 Measures of interest rate risk: Modified duration, money duration, and the price value
of a basis point (PVBP)
 How a bond’ maturity, coupon, and yield levels affect its interest rate risk
2. Modified Duration
The duration of a bond measures the sensitivity of the bond’s full price (including accrued
interest) to changes in interest rates. In other words, duration indicates the percentage
change in the price of a bond for a 1% change in interest rates. The higher the duration, the
more sensitive the bond is to change in interest rates.
There are two categories of duration: yield duration and curve duration.
 Yield duration measures a bond’s price sensitivity to changes in its own yield-to-
maturity and assumes underlying cash flows are certain.
 Curve duration measures a bond’s price sensitivity to changes in a benchmark yield
curve and accounts for the possibility that a bond may default.

As indicated in the diagram above, the main yield duration measures are: Macaulay duration,
modified duration, money duration, and the price value of the basis point (PVBP). Curve
duration measures are covered in later learning modules.
Macaulay duration is a weighted average of the time to receipt of the bond’s promised
payments, where the weights are the shares of the full price that correspond to each of the
bond’s promised future payments.

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

Modified duration provides an estimate of the percentage price change for a bond given a
change in its yield to maturity. It represents a simple adjustment to Macaulay duration as
shown in the equation below:
Macaulay duration
Modified duration =
1 + r
where: r is the yield per period.
Therefore, percentage price change for a bond given a change in its YTM can be calculated
as:
%ΔPV FULL ≈ −AnnModDur x ΔYield
The AnnModDur term is the annual modified duration, and the ΔYield term is the change
in the annual yield to maturity. The ≈ sign indicates that this calculation is estimation. The
minus sign indicates that bond prices and yields to maturity move inversely.
Example: Calculating the modified duration of a bond
A 2-year, annual payment, $100 bond has a Macaulay duration of 1.87 years. The YTM is 5%.
Calculate the modified duration of the bond.
Solution:
Modified duration = 1.87/(1 + 0.05) = 1.78
The percentage change in the price of the bond for a 1% increase in YTM will be:
-1.78 * 0.01 * 100 = -1.78%.
Approximate Modified Duration
Modified duration is calculated if the Macaulay duration is known. But there is another way
of calculating an approximate value of modified duration: estimate the slope of the line
tangent to the price-yield curve. This can be done by using the equation below:
(PV− ) − (PV+ )
Approximate Modified Duration =
2 ∗ ∆yield ∗ PV0
where:
PV_ = price of the bond when yield is decreased;
PV0 = initial price of the bond
PV+ = price of the bond when yield is increased

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

Source: CFA Program Curriculum, Understanding Fixed-Income Risk and Return

Interpretation of the diagram:
 PV0 denotes the original price of the bond.
 PV+ denotes the price of the bond when YTM is increased and PV_ denotes the bond
price when YTM is decreased.
 Change in yield (up and down) is denoted by Δ yield.
 For slope calculation: vertical distance = PV− − PV+ and horizontal distance = 2 x Δ
yield.
How to calculate approximate modified duration (or estimate the slope of the price-yield
curve):
 The yield to maturity is changed (increased/decreased) by the same amount.
 Calculate the bond price for a decrease in yield (PV-).
 Calculate the bond price for an increase in yield (PV+).
 Use these values to calculate the approximate modified duration.
Once the approximate modified duration is known, the approximate Macaulay duration can
be calculated using the formula below:
Approximate Macaulay Duration = Approximate Modified Duration x (1 + r)
Example: Calculating the approximate modified duration and approximate Macaulay
duration
Assume that the 6% U.S. Treasury bond matures on 15 August 2017 is priced to yield 10%
for settlement on 15 November 2014. Coupons are paid semiannually on 15 February and 15
August. The yield to maturity is stated on a street-convention semiannual bond basis. This
settlement date is 92 days into a 184-day coupon period, using the actual/actual day-count
convention. Compute the approximate modified duration and the approximate Macaulay

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

duration for this Treasury bond assuming a 50bps change in the yield to maturity.
Solution:
The yield to maturity per semiannual period is 5% (=10/2). The coupon payment per period
is 3% (= 6/2). When the bond is purchased, there are 3 years (6 semiannual periods) to
maturity. The fraction of the period that has passed is 0.5 (=92/184).
The full price (including accrued interest) at an YTM of 5% is 92.07 per 100 of par value.
3 3 3 3 3 103 92
( )
PV0 = [ + + + + + ] ∗ (1.05) 184
(1.05)1 (1.05)2 (1.05)3 (1.05)4 (1.05)5 (1.05)6
⇒ 89.85 × (1.05)0.5 = 92.07
Increase the yield to maturity from 10% to 10.5% - therefore, from 5% to 5.25% per
semiannual period, and the price becomes 90.97 per 100 of par value.
3 3 3 3 3 103
PV+ = [ + + + + + ]
(1.0525)1 (1.0525)2 (1.0525)3 (1.0525)4 (1.0525)5 (1.0525)6
92
∗ (1.0525)(184)
⇒ 88.67 × (1.0525)0.5 = 90.97
Decrease the yield to maturity from 10% to 9.5% - therefore, from 5% to 4.75% per
semiannual period, and the price becomes 93.19 per 100 of par value.
3 3 3 3 3 103
PV_ = [ + + + + + ]
(1.0475)1 (1.0475)2 (1.0475)3 (1.0475)4 (1.0475)5 (1.0475)6
92
∗ (1.0475)(184)
⇒ 91.05 × (1.0475)0.5 = 93.19
The approximate annualized modified duration for the Treasury bond is 2.41
93.19 − 90.97
ApproxModDur = = 2.41
2 ∗ 0.005 ∗ 92.07
The approximate annualized Macaulay Duration is 2.53
ApproxMacDur = 2.41 ∗ 1.05 = 2.53
Therefore, from these statistics, the investor knows that the weighted average time to
receipt of interest and principal payments is 2.53 years (the Macaulay Duration) and that the
estimated loss in the bond’s market value is 2.41% (the Modified Duration) if the market
discount rate were to suddenly go up by 1.0%.
3. Money Duration and Price Value of a Basis Point
Money Duration
The money duration of a bond is a measure of the price change in units of the currency in
which the bond is denominated, given a change in annual yield to maturity.
Money Duration = AnnModDur x PVFULL

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

ΔPVFULL ≈ -MoneyDur x Δyield

Consider a bond with a par value of $100 million. The current yield to maturity (YTM) is 5%
and the full price is $102 per $100 par value. The annual modified duration of this bond is 3.
The money duration can be calculated as the annual modified duration (3) multiplied by the
full price ($102 million): 3 x $102 million = $306 million. If the YTM rises by 1% (100 bps)
from 5% to 6%, the decrease in value will be approximately $306 million x 1% = $3.06
million. If the YTM rises by 0.1% (10 bps), the decrease in value will be $306 million x 0.1%
= $0.306 million.
Example: Calculating money duration of a bond
A life insurance company holds a USD 1 million (par value) position in a bond that has a
modified duration of 6.38. The full price of the bond is 102.32 per 100 of face value.
1. Calculate the money duration for the bond.
2. Using the money duration, estimate the loss for each 10 bps increase in the yield to
maturity.
Solution:
1. First calculate the full price of the bond: $1,000,000 x 102.32% = $1,023,200. The money
duration for the bond is: 6.38 × $1,023,200 = $6,528,000.
2. 10 bps corresponds to 0.10% = 0.0010. For each 10 bps increase in the yield to maturity,
the loss is estimated to be: $6,528,000 × 0.0010 = $6,528.02.
Price Value of a Basis Point (PVBP)
An important measure which is related to money duration is the price value of a basis point
(PVBP). The PVBP is an estimate of the change in the full price given a 1 bp change in the
yield to maturity. The formal equation is given below.
PV− − PV+
PVBP = 2
where PV_ and PV+ are full prices calculated by decreasing and increasing the YTM by 1
basis point.
A quick way of calculating the price value of a basis point is to take the money duration and
multiply by 0.0001. For example, if the money duration of a portfolio is $200,000 the price
value of a basis point is $200,000 x 0.0001 = $20. (1 bp = 0.01% = 0.0001)
Example: Calculating PVBP for a bond
Consider a $100, five-year bond that pays coupons at a rate of 10% semi-annually. The YTM
is 10% and it is priced at par. The modified duration of the bond is 3.81. Calculate the PVBP
for the bond.
Solution:
Money duration = $100 x 3.81 = $381.00

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

PVBP = $381 x 0.0001 = $0.0381

Exhibit 3 from the curriculum provides a summary of the various yield duration statistics.
Measure Calculation Use
Macaulay Average time to receipt of Holding period that would balance
duration promised cash flows, weighted by reinvestment and price risks for an
shares of the full price investor
corresponding to each promised
future cash flow
Modified First derivative of price with Estimate the percentage price
duration respect to yield; Macaulay duration change for a bond given a change
divided by 1 + yield per period in its yield-to-maturity
Money Modified duration multiplied by Estimate price change in bond
duration full price of bond or bond position investment for a given yield
change
Price value of a Difference in price of a 1 bp yield Estimate of the change in the bond
basis point decrease and a 1 bp yield increase, price given a 1 bp change in the
divided by 2 yield-to-maturity

Yield Duration of Zero-Coupon and Perpetual Bonds

Since zero-coupon bonds have a single payment, the face value at maturity the present
weighted-average time to receipt of cash flows is the same as the time-to-maturity. This is
because that single cash flow has a present value weight of 1. Therefore, the Macaulay
duration of a zero-coupon bond is its time to maturity. Its modified duration is time-to-
maturity divided by (1 + r).
A perpetual bond is one that does not mature. There is no principal to redeem. It makes a
fixed coupon payment forever. The Macaulay duration of a perpetual bond is (1 + r)/r.
Duration of Floating-Rate Notes and Loans
Interest rate risk for floating-rate instrument arises only between reset dates. Because at the
next reset date, the coupon payments will adjust to the new MRR. Therefore, the Macaulay
duration for a floating-rate bond is simply the fraction of a period remaining until the next
rest date. (T - t)/T
For example, if there are 180 days in the coupon period and 57 days have passed since the
last coupon, the Macaulay duration is: (180 - 57)/ 180 = 0.6833
4. Properties of Duration
The input variables for determining Macaulay and modified yield duration of fixed-rate
bonds are:

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

 Coupon rate or payment per period

 Yield to maturity per period
 Number of periods to maturity
 Fraction of the coupon period that has gone by
By changing one of the above variables while holding others constant, we can analyze the
properties of bond duration, which, in turn, helps us assess the interest rate risk. We will use
the formula for Macaulay duration to understand the relationship between each variable and
duration:
1+r 1 + r + [N ∗ (c − r)]
MacDur = { − } – (t⁄T)
r c ∗ [ (1 + r)N − 1] + r

The fraction of the coupon period that has gone by (t/T)

First, let us consider the relationship between fraction of time that has gone by (t/T) and
duration. There is no change to the expression in braces {} as time passes by. Fraction of
time (t/T) increases as time passes by. Assume T is 180. If 50 days have passed, then t/T =
0.277. If 90 days have passed, then t/T = 0.5. If 150 days have passed, then t/T = 0.83. As t/T
increases from t = 0 to t = T with passing time, MacDuration decreases in value. Once the
coupon is paid, t/T becomes zero and MacDuration jumps in value. When time to maturity is
plotted against MacDuration, it creates a saw tooth pattern as shown graphically below:

Interpretation of the Macaulay duration between coupon payments with a constant yield to
maturity:
 Note: Read the diagram from right to left. As time passes between coupon periods,
duration decreases in value.
 Once the coupon is paid, it jumps back up creating a saw tooth pattern.
Time to maturity
The following exhibit illustrates the relationship between Macaulay duration and the time to
maturity for premium, discount, zero-coupon and perpetual bonds.

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

 Zero-coupon bond: Pays no coupon so c = 0. Plugging in c = 0 and t/T = 0 in MacDur

formula, we get Macaulay Duration = N. For a zero-coupon bond, duration is its time
to maturity.
 Perpetuity: A perpetual bond is one that does not mature. There is no principal to
redeem. It makes a fixed coupon payment forever. If N is a large number in the above
equation, then the second part of the expression in the braces becomes zero.
1
Denominator: N is an exponent. (1 + r)N is a very large number. So (1 N must be
+ r)
zero and the value in the numerator will not matter here. Macaulay duration of a
1+r
perpetual bond is r
as N approaches infinity.
 Premium bond: Bonds are trading at a premium above par or at par. The coupon rate
is greater than or equal to yield to maturity (r). The numerator of the second
expression in braces is always positive because c-r is positive. The denominator of the
second expression in braces is always positive. Second expression as a whole is
1+r
always positive. MacDuration = less than r
because the second expression in
1+r
braces is positive. As time passes, it approaches r
.
 Discount bond: For a discount bond, the coupon rate is below yield to maturity. The
Macaulay Duration increases for a longer time to maturity. The numerator of the
second expression in braces is negative because c-r is negative. Put together, the
1+r 1+r
duration at some point exceeds , reaches a maximum, and approaches (the
r r
threshold) from above. This happens when N is large and coupon rate (c) is below the
yield to maturity (r). As a result, for a long-term discount bond, interest rate risk can
be lesser than a shorter-term bond.
Coupon rate and Yield-to-maturity
All else being equal, a lower-coupon bond has a higher duration and more interest rate risk
than a higher-coupon bond.
The same pattern holds for yield-to-maturity, a bond with a lower YTM has a higher duration

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

and more interest rate risk than a bond with a higher YTM.
This is because lower coupons and lower yields increase the weight of the maturity value or
final cash flow and reduce the weight of the nearer-term cash flows in the calculation for
Macaulay duration.
The relationship between a bond’s duration and its features are summarized in Exhibit 4 of
the curriculum.

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LM11 Yield-Based Bond Duration Measures and Properties 2025 Level I Notes

Summary
LO: Define, calculate, and interpret modified duration, money duration, and the price
value of a basis point (PVBP).
Macaulay duration is the weighted average of the time to receipt of coupon interest and
principal payments.
Modified duration is a linear estimate of the percentage price change in a bond for a 100
basis points change in its yield to maturity.
Macaulay Duration
Modified duration =
(1 + r)
FULL
% ∆ PV ≈ −AnnModDur ∗ ΔYield
(PV − ) − (PV + )
Approximate Modified Duration =
2 ∗ ∆ yield ∗ PV0
The money duration of a bond is a measure of the price change in units of the currency in
which the bond is denominated, given a change in annual yield to maturity.
Money Duration = AnnModDur ∗ PV FULL
∆ PV FULL ≈ −MoneyDur ∗ Δyield
The PVBP is an estimate of the change in the full price, given a 1bp change in the yield to
maturity.
PV− − PV+
PVBP =
2
LO: Explain how a bond’s maturity, coupon, and yield level affect its interest rate risk.
All else equal, a longer time-to-maturity, a lower coupon rate, or a lower YTM results in a
higher duration and higher interest rate risk.
Conversely, a shorter time-to-maturity, a higher coupon rate, or a higher YTM results in a
lower duration and lower interest rate risk.

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