What is the duration of a $100 million portfolio?
Portfolio duration is a measure used in finance to assess the sensitivity of a portfolio's value to changes in interest rates. It is particularly relevant for fixed-income investments such as bonds. The higher the portfolio duration, the more sensitive its value is to interest rate fluctuations.
To calculate the portfolio duration of a $100 million investment, we need to know the duration of each individual investment within the portfolio and the respective weights of each investment. The portfolio duration is a weighted average of the durations of the individual investments, where the weights represent the proportion of the total portfolio value that each investment holds.
Here's an example calculation, assuming a simplified scenario with two investments:
Investment 1:
- Investment Amount: $50 million
- Duration: 5 years
Investment 2:
- Investment Amount: $50 million
- Duration: 3 years
Portfolio Duration Calculation:
- Calculate the weighted duration of each investment:
- Weighted Duration of Investment 1 = (Amount of Investment 1 / Total Portfolio Amount) * Duration of Investment 1
- Weighted Duration of Investment 2 = (Amount of Investment 2 / Total Portfolio Amount) * Duration of Investment 2
- Calculate the total portfolio duration:
- Total Portfolio Duration = Weighted Duration of Investment 1 + Weighted Duration of Investment 2
Let's perform the calculations:
Weighted Duration of Investment 1 = (50,000,000 / 100,000,000) * 5 = 2.5 years
Weighted Duration of Investment 2 = (50,000,000 / 100,000,000) * 3 = 1.5 years
Total Portfolio Duration = 2.5 years + 1.5 years = 4 years
The portfolio duration of the $100 million investment is 4 years. This means that for every 1% change in interest rates, the value of the portfolio is expected to change by approximately 4%.
Keep in mind that this is a simplified example, and in a real investment portfolio, there could be many more investments with different durations and varying weights, leading to a more complex calculation of the portfolio duration. Additionally, other factors, such as the term to maturity of the individual investments, coupon rates, and convexity, can also impact the portfolio's sensitivity to interest rate changes. Professional financial analysts use sophisticated models to calculate and manage portfolio duration in practice.
