1. What is Effective Duration?

Effective Duration measures a bond's price sensitivity to changes in yield, accounting for embedded options. It's a key metric for fixed income traders to assess interest rate risk.

2. How Does the Calculator Work?

The calculator uses the Effective Duration formula:

Where:

• \( \frac{dP}{dy} \) — Price sensitivity to yield change (USD per 1 decimal yield change)
• \( P \) — Current price of the bond (USD)

Explanation: The formula shows how much a bond's price will change for a given change in yield, expressed in years of duration.

3. Importance in Trading

Details: Effective duration helps traders hedge interest rate risk, compare bond sensitivities, and construct duration-neutral portfolios.

4. Using the Calculator

Tips: Enter the bond's price sensitivity to yield (dP/dy) in USD per decimal yield change and the current price in USD. Both values must be positive.

5. Frequently Asked Questions (FAQ)

Q1: How is this different from Macaulay duration?
A: Macaulay duration assumes parallel yield curve shifts and no embedded options, while effective duration accounts for these factors.

Q2: What's a typical effective duration range?
A: Short-term bonds: 1-3 years, intermediate: 4-7 years, long-term: 8+ years. Zero-coupon bonds have duration ≈ maturity.

Q3: Why is duration negative in the formula?
A: The negative sign indicates the inverse relationship between price and yield - as yields rise, prices fall.

Q4: How does callability affect effective duration?
A: Callable bonds often have lower effective duration than option-free bonds, especially when rates fall and call likelihood increases.

Q5: Can effective duration be negative?
A: Yes, for instruments like mortgage IO strips that gain value when rates rise, though this is uncommon for standard bonds.