**Fixed Income II**

**Reading 46. Understanding Fixed-Income Risk and Return**

**Learning Outcome Statements**

f. calculate the duration of a portfolio and explain the limitations of portfolio duration;

*CFA Curriculum, 2020, Volume 5*

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**Subject 4. Bond Portfolio Duration**

*The weighted average of the time to receipt of aggregate cash flows.*This method is based on the**cash flow yield**, which is the internal rate of return on the aggregate cash flows.*The weighted average of the durations of individual bonds that compose the portfolio.*The weight is the proportion of the portfolio that a bond comprises.Portfolio Duration = w _{1}D_{1}+ w_{2}D_{2}+ w_{3}D_{3}+ ... + w_{k}D_{k}

w_{i}= the market value of bond i / market value of the portfolio

D_{i}= the duration of bond i

k = the number of bonds in the portfolio

To illustrate this calculation, consider the following three-bond portfolio in which all three bonds are option-free:

- 10% 5-year 100.0000 10 $4 million $4,000,000 3.861
- 8% 15-year 84.6275 10 $5 million $4,231,375 8.047
- 14% 30-year 137.8586 10 $1 million $1,378,586 9.168

In this illustration, it is assumed that the next coupon payment for each bond is exactly six months from now (i.e., there is no accrued interest). The market value for the portfolio is $9,609,961. Since each bond is option-free, modified duration can be used.

- w1 = $4,000,000/$9,609,961 = 0.416, D1 = 3.861
- w2 = $4,231,375/$9,609,961 = 0.440, D2 = 8.047
- w3 = $1,378,586/$9,609,961 = 0.144, D3 = 9.168

The portfolio's duration is: 0.416 (3.861) + 0.440 (8.047) + 0.144 (9.168) = 6.47.

A portfolio duration of 6.47 means that for a 100 basis point change in the yield for each of the three bonds, the market value of the portfolio will change by approximately 6.47%. Keep in mind that the yield for each of the three bonds must change by 100 basis points for the duration measure to be useful. This is a critical assumption and its importance cannot be overemphasized.

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**User Contributed Comments**
9

You need to log in first to add your comment. ###### WaheedAbbasKhan

can anyone help? what does this mean?

"10% 5-year 100.0000 10 $4 million $4,000,000 3.861"

10% copuon - 5Year Maturity - FV100 - next?

###### zackychoo

10 is 10%, the interest rate.

$4 mill is the total par val of the bonds

$4,000,000 is the total market value of the bonds, which is equal to par value because coupon rate is equal to interest rate.

3.861 is the duration.

###### papajeff

This is hands down the shittiest part of the whole course.

###### johntan1979

Nah... this is an easy piece of shit.

Econ is the worst, whether micro or macro.

###### gill15

This is easy crap. Problem is i think nobody reads the notes as we're nearing the end of lessons....

Accounting ---- by far the worst and most boring --- Taxes still scare me..

###### ldfrench

This sections sucks. Accounting sucks too.

###### farhan92

eco is fun -except the global eco! Fixed income is just shitty

###### sandra1010

Can someone help?

How did you get the market value of 4,231,375?

###### bemccall95

sandra1010 you do the par value of 5,000,000 times the discount value of 0.846275 to get the market value