Effective Duration Formula:
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Effective Duration measures the sensitivity of a bond's price to changes in yield, adjusted for the compounding frequency. For stocks or hybrid securities, it helps assess interest rate risk.
The calculator uses the Effective Duration formula:
Where:
Explanation: The formula adjusts modified duration for the compounding effect of the yield, providing a more accurate measure of interest rate risk.
Details: Effective duration is crucial for assessing interest rate risk in bonds, preferred stocks, and other fixed-income securities. It helps investors understand how much a security's price might change with interest rate movements.
Tips: Enter modified duration in years, yield as a decimal (e.g., 0.05 for 5%), and frequency as compounds per year (e.g., 2 for semiannual). All values must be positive.
Q1: How is effective duration different from modified duration?
A: Effective duration accounts for the compounding frequency of yields, making it more precise than modified duration for bonds with embedded options or irregular cash flows.
Q2: Can this be used for common stocks?
A: While primarily for bonds, it can be adapted for preferred stocks or stocks with bond-like characteristics.
Q3: What's a typical effective duration range?
A: Duration varies by security type: short-term bonds (1-3 years), intermediate (4-7 years), long-term (8+ years).
Q4: How does frequency affect the calculation?
A: Higher frequency (more compounding periods) results in lower effective duration, as the yield's impact is spread more evenly.
Q5: Why is this important for stock investors?
A: For hybrid securities or income-focused portfolios, understanding duration helps manage interest rate risk.