Key Rate Duration
What it is:
Key rate duration is not the same as Effective duration is an estimate of a security's sensitivity to a parallel shift in interest rates, meaning that it assumes that interest rates change by the same degree for, say, one-year , five-year bonds, 10-year bonds, and 30-year bonds. That's not often the case in the real world, which is why key rate duration is useful -- it measures a security's price sensitivity to shifts at "key" points along the . Key rates are especially useful for securities with embedded options such as call options or prepayment options..
How it works/Example:
Why it matters:
Key rate duration is a measure of how a security's value changes when its yield changes by 1% for a certain maturity.
The formula for key rate duration is:
Key Rate Duration = (P- - P+)/(2 * 0.01 * P0)
Where P- = the security price after a 1% decrease in yield
P+ = the security price after a 1% increase in yield
P0 = the original security price