1. What is Effective Duration?

Effective Duration measures a bond's price sensitivity to changes in interest rates, accounting for potential changes in expected cash flows. It's particularly useful for bonds with embedded options.

2. How Does the Calculator Work?

The calculator uses the Effective Duration formula:

Where:

• \( \Delta Price \) — Change in bond price (USD)
• \( Price \) — Current bond price (USD)
• \( \Delta Yield \) — Change in yield (decimal)

Explanation: The formula calculates the percentage change in price for a given change in yield, then normalizes it by the yield change.

3. Importance of Effective Duration

Details: Effective Duration helps investors understand interest rate risk, compare bonds with different characteristics, and construct immunized portfolios.

4. Using the Calculator

Tips: Enter price change in USD, current price in USD, and yield change as a decimal (e.g., 0.01 for 1%). All values must be valid (price > 0, ΔYield ≠ 0).

5. Frequently Asked Questions (FAQ)

Q1: How is effective duration different from modified duration?
A: Effective duration accounts for changes in cash flows due to embedded options, while modified duration assumes cash flows remain constant.

Q2: What does a higher effective duration indicate?
A: Higher duration means greater price sensitivity to interest rate changes - prices will change more for a given yield change.

Q3: Can effective duration be negative?
A: Yes, for certain bonds like some mortgage-backed securities where price may increase when yields rise.

Q4: How often should effective duration be calculated?
A: For bonds with embedded options, duration should be recalculated whenever market conditions change significantly.

Q5: What are typical effective duration values?
A: Most bonds have durations between 1-20 years. Short-term bonds have lower durations, long-term bonds have higher durations.