![]() ![]() If an investor clearly knows how he or she expects interest rates to move over a given time frame, they can then use the key rate duration metric to figure out which bond maturities are likely to offer the most profitable investment returns (assuming that the investor’s interest rate predictions prove to be correct). Treasuries, and the investor can calculate the key duration for every different maturity level. There are more than ten different bond maturities for U.S. It assumes the yields for all other maturities are kept the same. The key rate duration reflects the expected change in value resulting from a yield change for a bond or bond portfolio with a specific maturity. ![]() Key Rate Duration = (1030 – 980) / (2 * 0.01 * 1000) = 2.5 Significance of the Key Rate Duration Using the formula shown above, the bond’s key rate duration would be calculated as follows: P + – /the bond’s price after a 1% increase in yieldĪssume that a given bond is originally priced at $1,000 and that a 1% increase in yield for the bond’s maturity would cause the value of the bond to decline to $980, while a 1% yield decrease would result in the bond’s value increasing to $1,030.P – – A bond’s price after a 1% decrease in yield.Formula for Calculating the Key Rate Duration The key rate duration represents an improvement over the effective duration measure because it indicates predicted changes in price/value when there are shifts in the yield curve that are not parallel across all maturities. In fact, interest rates for different maturities of bonds may even be moving in opposite directions, with, for example, long-term interest rates increasing while the interest rate on short-term bonds is declining. Interest rate increases or decreases for short-term bonds do not typically parallel rate increases or decreases for long-term or medium-term bonds. In real life, such a phenomenon rarely, if ever, occurs. It is because the effective duration metric is only applicable to parallel shifts in interest rates and the yield curve – when interest rates for all the various bond maturities simultaneously increase or decrease by the same amount. The key rate duration is considered a superior metric to effective duration. Using the metric can help investors or financial analysts predict the probable profitability of investing in bonds with various maturities.Key rate duration is considered an improvement over using the effective duration metric, which can only be applied when there are parallel changes in the yield all across the yield curve.The key rate duration is an important metric for determining possible bond value changes resulting from yield changes for the bond’s maturity.
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