Effective duration indicates the sensitivity of a bond’s price to a 100-bps parallel shift of the benchmark yield curve in particular, the government par curve; assuming no change in the bond’s credit spread.
The flowing procedure is used to apply this formula in practice.
The following figure compares the effective duration of option-free, callable and putable bonds.
The effective durations of various types of instruments are shown in the table below.
|Type of Bond||Effective Duration|
|Zero-coupon bond||≈ Maturity|
|Fixed-rate bond||< Maturity|
|Callable bond||≤ Duration of straight bond|
|Putable bond||≤ Duration of straight bond|
|Floater (Libor flat)||≈ Time (in years) to next reset|