1. Economics 434 Financial Markets Professor Burton University of Virginia Fall 2015 November 3, 2015

2. Duration – One More Time Pure Definition: (dP/dy)/P – Percentage drop in value of bond for a small increase in yield But McCauley Duration is: weighted average of maturities of payments where the weights are the fraction of present value that is embodied in that specific payment with the specific maturity November 3, 2015

3. Economics 434 – Financial Market Theory Tuesday, Oct 20, 2015 Continuing Rearranging gives: P P

4. Duration Equals McCauley Duration for a treasury bond or note PP Duration McCauley Duration Is approximately equal to 1

5. Duration Equals McCauley Duration for a treasury bond or note PP Duration McCauley Duration Is approximately equal to 1

6. Example, Recent 2 Year Note Coupon 5/8 – Means payments twice yearly of 5/8 divided by 2 multiplied by $ 1,000 = $ 312.50 November 3, 2015 divided by P McCauley Duration is = 1 times w 1 plus 2 times w 2 plus 3 times w 3 plus 4 times w 4

7. Meanwhile Back to ABS Broad principles – Create a pool of fixed income securities (or could be bank loans)…debt instruments generally – Using the pool’s cash flows, create brand new securities with usually a wide range of credit quality New securities created are driven by demand for certain credit qualities and durations (where such combinations may not be currently available) November 3, 2015