Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. A bond’s duration is easily confused with its term or time to maturity because certain types of duration measurements are also calculated in years.
· Duration measures a bond’s or fixed income portfolio’s price sensitivity to interest rate changes
· Macaulay duration estimates how many years it will take for an investor to be repaid the bond’s price by its total cash flows.
· Modified duration measures the price change in a bond given a 1% change in interest rates.
· A fixed income portfolio’s duration is computed as the weighted average of individual bond durations held in the portfolio.
Duration is defined as the length of time that something lasts. When a film lasts for two hours, this is an example of a time when the film has a two hour duration. A measurement of bonds price sensitivity of changes in interest rates.
Options: Options are a form of derivative financial instrument in which two parties contractually agree to transact an asset at a specified price before a future date. An option gives its owner the right to either buy or sell an asset at the exercise price but the owners is not obligated to exercise (buy or sell) the option.
When an option reaches its expiration date without being exercised, it is rendered useless with no value. There are two types of options: calls and puts
· Call options allow the option holder to purchase an asset at a specified price before or at a particular time.
· Put options are opposites of calls in that they allow the holder to sell an asset at a specified price before or at a particular time.
For example, a stock options is for 100 shares of the underlying stock. Assume a trader buys one call option contract on ABC stock with a strike price of $25. He pays $150 for the option. On the option’s expiration date, ABC stock shares are selling for $35.
The holder of a call speculates that the value of the underlying asset will move above the exercise price (strike price) before expiry. Conversely, a holder of put option speculates that the value of the underlying asset will move below the exercise price before expiry.