DV01 is not identical to duration, but it is a closely related measure of interest rate risk. While duration typically measures the percentage price change for a 1% yield move, DV01 (Dollar Value of an '01) measures the specific dollar change in a bond's price for a 1 basis point (0.01%) shift in yield.
Effective duration measures the percentage change in the price of a bond (or other instruments) caused by small changes in all rates. Note that effective duration is different from DV01 because DV01 measures actual price changes against small changes in all rates.
For example, if the modified duration of a Treasury security is 6.23 years, the DV01 of the instrument is: [ (0.01 x Modified Duration) x Price ] x 0.01 = DV01 [ (0.01 x 6.23) x $108,593.75 ] x 0.01 = $67.65 If you break down the formula, you find three components: a.
DV01 is appropriate to consider the impact of rate changes on the value of a position in dollars. Effective duration is appropriate to consider the impact of rate changes on the value of a position as a percentage.
While duration gives an estimate of the percentage price change for a given yield change, PVBP provides the actual dollar value of that price change. By knowing the PVBP of a bond or a portfolio of bonds, investors can better evaluate their exposure to changes in interest rates.
The PVBP is also called the “PV01”, standing for the “price or present value of 01”, where “01” means 1bp. In the United States, it is commonly called the “DV01” (Dollar value).
There are three types of bond durations namely, Macaulay duration, modified duration and effective duration. A Macaulay duration represents the weighted average time before a bond's cash flows are fully paid and provides an effective way of measuring the time until an investor will get their money back.
DV01 is the monetary change in bond price for 1 basis point change in interest rates (by default it is usually expressed as price change for 1bp increase in interest rates). There can also be DV01's for credit spreads (sometimes referred to as CR01) and inflation rates.
There are a number of ways to calculate duration, but the term is generally used to refer to “effective duration.” This shows the approximate percentage change in a bond's value in response to a percentage point change in yield.
The effective interest rate—often used interchangeably with the terms effective annual rate (EAR) or annual equivalent rate (AER)—provides the actual annual interest rate paid on a loan or debt security since the impact of compounding within a given year is accounted for.
[1] Macauley Duration is calculated by summing up all the multiples of the present values of cash flows and corresponding time periods and then dividing the sum by the market bond price. [2] Modified Duration is calculated by dividing the Macaulay Duration by one plus the yield to maturity.
Zero-coupon bonds are popular (in exams) due to their computational convenience. We barely need a calculator to find the modified duration of this 3-year, zero-coupon bond. Its Macaulay duration is 3.0 years such that its modified duration is 2.941 = 3.0/(1+0.04/2) under semi-annually compounded yield of 4.0%.
Effective duration (sometimes called option-adjusted duration, or “OAD”) is the duration for a bond with an embedded option when the value is calculated to include the expected change in cash flow caused by changes in market interest rates.
(yield-based) DV01 = Price * (Modified) Duration / 10,000
both give the (linear, approximate) estimate of bond price change for a shift in yield, DVO1 (in $, for 1 bsp), modified duration (in % terms, for 1 unit change).
Duration: The Net Effect
It is a more precise measure of the life of a bond than maturity because it takes into consideration any cash flows that are received prior to maturity. In general, the sooner cash flows are received and the larger the amount, the lower the duration, or interest rate risk, of the bond.
Duration is a measurement, in years, that assesses the interest-rate sensitivity of a bond. There are two types of bond duration: Macaulay duration and modified duration. Both are measured in years and assess a bond's interest-rate sensitivity.
Duration is how long something lasts, from beginning to end. A duration might be long, such as the duration of a lecture series, or short, as the duration of a party. The noun duration has come to mean the length of time one thing takes to be completed.
In finance, the dollar value of a basis point, or DV01, is a measure of how the price of a bond changes in response to a change in yield. It is also known as the present value of one basis point, or PV01.
So how does duration fit in? Investors holding a high duration bond need to wait longer for the bond's value to be repaid. But over a longer timeline, it is more likely that interest rates will rise, which means there is a higher likelihood that the bond's value will decline.
The dollar value decrease in the price of a bond due to a 1 basis point, upward parallel shift in the yield curve. Commonly referred to as DV01. It is the duration times the bond price divided by 100. The amount of the bond outstanding as of the corporations's latest available balance sheet.
Effective duration is a duration calculation for bonds that have embedded options. It is used to measure the risk that expected cash flows will fluctuate as interest rates change. Effective duration can be estimated using modified duration if a bond with embedded options behaves like an option-free bond.
Key Takeaways. Dollar duration, or DV01, measures the dollar change in a bond's value for every 100 basis point change in interest rates. It is a useful tool for bond fund managers to approximate a portfolio's interest rate risk in dollar terms.
It is a fundamental measure used to determine the sensitivity of a bond's price to interest rate changes. The Macaulay Duration is calculated by summing the present values of all cash flows, each multiplied by the time until receipt, and then dividing by the current bond price.