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Dear John,
In 2nd lecture video on chapter 11, you mention Macaulay Duration is “the avg time taken to return half our money”, but the lecture notes says it is “the average time it takes for a bond to pay its interest and principal”. So which is right? is it average time to get back half the money or the full ineterest and principal?
Thanks
They are two ways of saying the same thing (as far an investor is concerned).
Excuse my ignorance, but if the full amount of interest and the principal is same as half our money in the above context, then what is the remaining half of the money?
Sorry, I should have explained in more detail (I was abroad at the time and had jet-lag 🙂 ).
Both statements are standardly used to describe it, but neither really explains it clearly.
The point is that if you buy a bond redeemable in (say 5 years), you can of course hold it for the full 5 years, and the price you pay for the bond will be equal to the PV of the cash flows over the whole 5 years (interest and repayment).
However you could sell it at any time within the 5 years, and the price you will sell it at will be the then PV of the remaining flows.What the Macauley Duration is measuring is the average time you would need to hold the bonds to get back the amount you paid for the bonds (the interest for that period plus the sales proceeds at the end of that period). (So if the Macauley Duration were (say) 3 years, then you should be prepared to hold the bonds for 3 years to be confident of having got your money back.)
This will be approximately the same as the average time taken to get back half the amount paid if you were not to sell the bonds at the end of that period but wait all 5 years.
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Hi Sir I got similar confusion in this section as well.
In example you explain above, you said if a 5 year bond with 3 year Macauley duration, then we need to hold the bond for 3 year to get back the amount you paid for the bonds.
Assuming everything is constant for 5 year, is the value of the bond should always at the PV of interest and repayment? If this is the case,
Selling in Year 2: PV of Year 1-2 interest + PV of value of bond in end of year 2
Selling in Year 4: PV of Year 1-4 interest + PV of value of bond in end of year 4arent both example above should always provide the same PV regardless when investors will sell the bond before maturity? Why it says it should hold for 3 year to get back the amount paid?
Sorry I was confuse in this part. Please correct me if I am wrong.
Thank you.
But the problem is that the required rate of return is unlikely to stay constant over the 5 year period, and that will affect the MV’s, as I show in my examples in the free lectures.
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How does the change in rate of return required relate to a bond with 5 year maturity period and 3 year macaulay duration?
I understand the increase in rate of return required will result decrease in macaulay duration and modified duration, but what does the 3 year macaulay duration can be interpret when change in rate of return? Can sir provide some example? Thank you.
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