Definition of 'Average Life'
The average life of a bond is important because it can affect the yield of the bond. A bond with a longer average life will have a lower yield than a bond with a shorter average life. This is because the longer the bond has to mature, the more time there is for interest rates to rise, which will reduce the value of the bond.
The average life of a bond can also be used to compare bonds with different maturities. For example, a bond with a 10-year maturity and a 5-year average life will have a higher yield than a bond with a 10-year maturity and a 10-year average life. This is because the shorter average life means that the bond is more likely to mature before interest rates rise.
The average life of a bond can be calculated using the following formula:
Average life = S(t/n)
t = number of years until each bond matures
n = number of bonds
For example, if you have a bond portfolio with 5 bonds, each with a different maturity, you can calculate the average life of the portfolio using the following formula:
Average life = (1/5) * (1 + 2 + 3 + 4 + 5) = 3 years
This means that the average bond in your portfolio will mature in 3 years.
The average life of a bond is a useful tool for investors who are looking to compare bonds with different maturities. It can also be used to estimate the yield of a bond.
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