Risk exposure with Bonds: the Duration

What the hell is the “Duration”??

The Duration tells you how long, in years, it takes for the coupons to repay the price of a bond. It is the weighted average maturity of a bond’s cash flows or of any series of linked cash flows. The Macauley formula that gives a way to calculate the Duration goes like this:

Why is it important?

It is an important factor to know as it gives you a way to quantify the risk you bear in investing in bonds. Long term bonds have a higher Duration than short term bonds.

Free: Monte Carlo simulator in Excel

Now it’s time for hands-on…

First you need to download a small library that you can find here: download
The author did a great job here and will save you lots of time… (I take no credit for the writing of this fantastic piece of script)
Install it by 2x clicking on the file and follow the instructions.

If the install is properly done you’ll see a new toolbar showing up in Excel with barbaric names like “Insert Input“, “Insert Output“, “Insert Correlation“….

Your first Monte Carlo using Crystal Ball

Hi again,

Today we’ll see how to run a simple Monte Carlo simulation using Crystal Ball.
We’ll also see how to interpret some results.

What’s the aim?

Our aim is 2-fold:
- Assess the profitability of a project
- Understand what are the most important variables impacting our profitability

Defining Assumptions – Part 3: Normal Distribution

Now we know we can use the Uniform Distribution in a few cases, how about the Normal Distribution? This distribution is frequently used.
This is mainly due to the result of the Central Limit Theorem which states that the mean of a set of values drawn from the same distribution will be “Normally” described.

Other distributions also tend towards Normal at their limits (e.g. Poisson and Binomial distributions).

What does it look like?

Defining Assumptions – Part 2: Triangular Distribution

The Triangular Distribution is is the most commonly used distribution.
It has no theoretical justification though. However, it is a very simple and clear distribution to use.

Note: It overestimates the size of the tails at the expense of values close to the mean.