I have difficulty with the duration of a 5 year investment (like GIC). In such an investment, the investment (GIC) rate is reset as the current market rates. So the market value is equal to the face amount at the beginning of each rolling period. The investment is automatically renewed every 5 years in the future. Now the investment is in its 4th anniversary (i.e. after 4 years of purchase). What is the duration of the investment? Is it approximately 1 year or 5 year or something in the middle?
1 Answer
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The duration represents the sensitivity of the price of a financial instrument to current interest rates. Since at the rolling date the price will be equal to the face value no matter what happens to interest rates today (the interest rate will be reset at a future date), the rolling does not add any price sensitivity to an instantaneous interest rate shock. So the duration of your rolling investment is equal to current investment, i.e. 1.
