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The need for Market Valuation of your



SFFAS 1 – Accounting for Selected Assets and

72. Disclosure of market value. For investments

in Market-based and marketable Treasury
securities, the market valuation should be
From the FedInvest system you can select Prior Days
Prices which takes you to a listing of price files. You can
choose the price file for the particular day you wish to
value your portfolio.
Once you choose the price file you use the End
of Day price to calculate your market value.
• We know:
– An increase in interest rates causes
bond prices to fall, and a decrease in
interest rates causes bond prices to

• We also know that longer maturity debt

securities tend to be more volatile in
– For a given change in interest rates, the
price of a longer term bond generally
changes more than the price of a shorter
term bond.
• Two bonds with the same term to
maturity do not have the same
interest-rate risk.
– A 10 year zero coupon bond makes all
of its payments at the end of the
– A 10 year coupon bond makes
payments before the maturity date.
• When interest rates rise, the prices
of low coupon securities tend to fall
faster than the prices of high
coupon securities.
• Similarly, when interest rates
decline, the prices of low coupon
rate securities tend to rise faster
than the prices of high coupon rate
• Knowledge of the impact of
varying coupon rates on security
price volatility led to the
development of a new index of
maturity other than straight
• calendar
The new time.
measure permits analysts
to construct a linear relationship
between term to maturity and
security price volatility, regardless
of differing coupon rates.
is the measure of the price sensitivity of
a fixed-income security to an interest
rate change of 100 basis points. The
calculation is based on the weighted
average of the present values for all
cash flows.
Duration is measured in years; however,
do not confuse it with a bond’s maturity.
For all bonds, duration is shorter than
maturity except zero coupon bonds,
whose duration is equal to maturity. This
is because all cash flows are received at
The term “duration,” having a special meaning in the context of bonds, is
a measurement of how long in years it takes for the price of a bond to be
repaid by its internal cash flows. It is an important measure for investors
to consider, as bonds with higher durations are more risky and have
higher price volatility than bonds with lower durations.

For each of the two basic types of bonds the duration is the following:
1. Zero-coupon bond – Duration is equal to its time to maturity.
2. Straight bond – Duration will always be less than its time to
Here are some visual models that demonstrate the properties of duration
for a zero-coupon bond and a straight bond.
Duration of a Zero-Coupon Bond

The red lever above represents the four-year time period it takes for a zero
coupon to mature. The money bag balancing on the far right represents the
future value of the bond, the amount that will be paid to the bondholder at
maturity. The fulcrum, or the point holding the lever, represents duration,
which must be positioned where the red lever is balanced. The fulcrum
balances the red lever at the point on the time line when the amount paid
for the bond and the cash flow received from the bond are equal. Since the
entire cash flow of a zero-coupon bond occurs at maturity, the fulcrum is
located directly below this one payment.
Duration of a Straight Bond
Consider a straight bond that pays coupons annually and matures in five years.
Its cash flows consist of five annual coupon payments and the last payment
includes the face value of the bond.

The moneybags represent the cash flows you will receive over the five-year period.
To balance the red lever (at the point where total cash flows equal the amount
paid for the bond), the fulcrum must be further to the left, at a point before
maturity. Unlike the zero-coupon bond, the straight bond pays coupon payments
throughout its life and therefore repays the full amount paid for the bond sooner.
Factors Affecting Duration
It is important to note, however, that duration changes as the coupons are
paid to the bondholder. As the bondholder receives a coupon payment, the
amount of the cash flow is no longer on the timeline, which means it is no
longer counted as a future cash flow that goes towards repaying the
bondholder. Our model of the fulcrum demonstrates this: as the first
coupon payment is removed from the red lever (paid to the bondholder), the
lever is no longer in balance (because the coupon payment is no longer
counted as a future cash flow).
The fulcrum must now move to the right in order to balance the
lever again:

Duration increases immediately on the day a coupon is paid, but throughout

the life of the bond, the duration is continually decreasing as time to the
bond’s maturity decreases. The movement of time is represented above as
the shortening of the red lever: notice how the first duration had five payment
periods and the above diagram has only four. This shortening of the timeline,
however, occurs gradually, and as it does, duration continually decreases. So,
in summary, duration is decreasing as time moves closer to maturity, but
duration also increases momentarily on the day a coupon is paid and removed
from the series of future cash flows – all this occurs until duration, as it does
for a zero-coupon bond, eventually converges with the bond’s maturity.
Duartion – Other factors:
Coupon rate and Yield also affect the bond’s duration. Bonds with high
coupon rates and in turn high yields will tend to have a lower duration
than bonds that pay low coupon rates, or offer a low yield. This makes
sense, since when a bond pays a higher coupon rate the holder of the
security received repayment for the security at a faster rate. The
diagram below summarizes how duration changes with coupon rate and
The formula usually used to calculate a bond’s basic duration is the
Macaulay duration, which was created by Frederick Macaulay in 1938 but
not commonly used until the 1970s.
Macaulay duration is calculated by adding the results of multiplying the present
value of each cash flow by the time it is received, and dividing by the total price
of the security. The formula for Macaulay duration is as follows:

n = number of cash flows

t = time to maturity
C = cash flow
i = yield to maturity
M = maturity par value

Let’s go through an example:

If you hold a five-year bond with a par value of $1,000 and a coupon rate of 5%.
For simplicity, assume that the bond is paid annually and that interest rates are
3% (yield).
n = number of cash flows
t = time to maturity
C = cash flow
i = yield to maturity
M = maturity par value

Fortunately if you are seeking the Macaulay duration of a zero-coupon bond, the
duration would be equal to the bond’s maturity, so there is no calculation
Therefore…the lower the coupon rate, the
higher the duration of the bond.
Coupon Bonds: duration is shorter than
 Discount bonds (yield is greater than
coupon): duration increases at a decreasing
rate up to a point, after which it declines

 Par value bonds: duration increases with


 Premium bonds (yield is less than coupon):

duration increases throughout but at a lesser
rate than with a par value bond.
 Duration depends on yield-to-maturity.

 The higher the yield the shorter the

duration, other things being equal.
 In Treasury bonds, the only source of
risk stems from interest rate
 Duration is a measure of this source
of risk.

 Duration allows bonds of different

maturities and coupon rates to be
directly compared.
basis]) calculates the annual duration for a security that
pays periodic interest.

A security has a July 1, 1993, settlement date and a
December 1, 1998, maturity date. The semiannual coupon
rate is 5.50% and the annual yield is 5.61%. The bond has a
30/360 day-count basis.
To determine the security's annual duration:
2;0) = 4.734591

A bond has the following terms:
January 1, 1998, settlement date
January 1, 2006, maturity date
8 percent coupon
9.0 percent yield
Frequency is semiannual
Actual/actual basis
The duration (in the 1900 date system) is:
equals 5.993775
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Include which report (Market Valuation and/or

Duration) you would like to receive, the
Account Fund Symbol(s), and a date for which
you want the information.