What Is the Macaulay Duration?
Macaulay duration is a method to calculate the average time it takes to receive the cash flows generated by a bond by considering the bond's maturity date. In the case of a zero-coupon bond, the Macaulay duration is simply the remaining time until it matures. Calculating Macaulay duration can be a bit complex, but it can be made easier using Excel.
Basics
Macaulay Duration serves as the economic equilibrium marker for a set of cash flows. Alternatively, it signifies the investor's requisite duration to hold a bond position until the present value of the bond's cash flows matches the bond's purchase price.
Exploring the Macaulay Duration
In essence, the Macaulay duration denotes the period for an investor to recoup their entire bond investment through periodic interest and principal repayments. It mirrors the duration of a debt fund, measured in years. This duration is calculated as a weighted average of Macaulay durations of its securities.
Several factors (price, maturity, coupon, and yield to maturity) affect duration computation. Maturity and duration rise in tandem, while an increasing coupon correlates with decreased duration. Elevated interest rates diminish duration and the bond's susceptibility to further rate hikes. Sinking funds, prepayments, and call provisions can also curtail a bond's duration. For zero-coupon bonds, Macaulay duration equals the time to maturity. These interest-free fixed-income securities, trading at a discount, offer profitability upon redemption at face value during maturity.
Macaulay Duration Formula
Where:
- ti = The time until the ith cash flow from the asset will be received
- PVi = The present value of the ith cash flow from the asset
- V = The present value of all cash flows from the asset
The computation of Macaulay duration, though intricate with several variations, primarily involves adding the product of the coupon payment per period and the time to maturity, divided by one plus the yield per period raised to the time to maturity. This result is then combined with the total number of periods multiplied by the bond's par value, divided by one plus the yield per period raised to the total number of periods. The final outcome is divided by the current bond price.
Excel Computation of Macaulay Duration
To compute Macaulay Duration in Excel, consider a two-year zero-coupon bond with a $10,000 par value and a 5% yield.
- In columns A and B, right-click on the columns, select "Column Width," and change the value to 30 for both columns.
- Next, enter "Par Value" into cell A2, "Yield" into cell A3, "Coupon Rate" into cell A4, "Time to Maturity" into cell A5, and "Macaulay Duration" into cell A6.
- Enter "=10000" in cell B2, "=0.05" into cell B3, "=0" into cell B4, and "=2" into cell B5.
- In cell B6, enter the formula "=(B4 + (B5*B2)/(1+B3)^1) / ((B4 + B2)/(1+B3)^1)."
Since a zero-coupon bond has only one future cash flow and does not pay any coupons, its Macaulay duration equals its time to maturity.
Conclusion
Macaulay duration, a key metric for investors, reflects the time to receive bond cash flows. For zero-coupon bonds, it equals the time to maturity. Excel simplifies the intricate calculation process. Understanding the economic equilibrium and investor commitment enriches the exploration of Macaulay duration, with its formula involving factors like coupon payments and yield. The practical example in Excel underscores the utility of Macaulay duration in bond investment assessment.