How Do I Calculate Interest Rate Sensitivity on Bonds?

How Do I Calculate Interest Rate Sensitivity on Bonds?
How Do I Calculate Interest Rate Sensitivity on Bonds?

Create six columns on a blank piece of paper labeled Year, Cash Flows, Interest, Factor, Discount Factor and Year x Discount Factor.

Write out the numbers 1 through 10 under the Year column, creating 10 rows.

Write the number $5,000 under the Cash Flows column next to each number, 1 through 9.

Write the number $105,000 next to the number 10 in the Cash Flows column.

Write the number 1.05 in every row 1 through 10 under the Interest column.

Calculate the discount factor in each row of the Factor column by using a calculator to raise the 1.05 number from the Interest column by the power determined by the number in the corresponding Year column. For example, in the first row, the calculation is 1.05^1, or 1.05. In the last row, or year, the calculation is 1.05^10, or 1.63.

Divide the discount factor into the cash flow number row by row in the Discount Factor column. For example, in row 1, the number is 5,000/1.05 = 4,762. In the final row, the number is 105,000/1.63 = 64,417.

Multiply the year number times the number in the corresponding row of the Discount Factor column. The first number will be 1 x 4,762= 4,762, and the last number will be 10 x 64,417 = 644,170.

Add up all of the numbers in the last column to get an answer of 810,345.

Divide 810,345 by the face value of the bond, or 100,000. The answer is 8.10, which is the duration of the bond. This means that if interest rates rise from 5 to 6 percent, the value of the bond will fall by 8 percent.