C - CIA Duration

Question 1

CIA DURATION

Contrast 3 types of Duration

Answer 1

MACAULAY DURATION
=sum ( t x PV(CF) ) / sum (PV(CF))

MODIFIED DURATION
measures sensitivity to PV(CF) to change in interest rates
= macaulay duration / (1 + yield)

EFFECTIVE DURATION
measures sensitivity to PV(CF) to change in interest rates (similar to modified duration)
would be almost equal to modified duration if CF value does not change with interest rates.

If CF changes with Interest rates (for derivatives), effective duration with also capture sentitivity to this change

=( Fair Value if yield decline - Fair Value if yield rise ) / 2 * initial price * chg in yield
= (V- - V+) / ( 2 * V0 * delta Y)

Question 2

CIA DURATION

DISADVANTAGE of
EFFECTIVE and MODIFIED Duration

Answer 2

they provide exact percentage change for small very change in interest rates, but are less accurate for large changes because relationship in chg in interest rate and chg in PV(CF) is not linear.

Question 3

CIA DURATION

considerations on duration when performing calculation of interest rate risk margin in MCT

Answer 3

May use either EFFECTIVE or MODIFIED DURATION (not MACAULAY)

SAME methodology must apply to ALL assets and liabilities

SAME methodology must apply YoY

EFFECTIVE is THE REQUIRED MEASURE when interest changes may change expected CF