The Term of a Risk-Free Security

In the late 1930s, Macaulay [7] and Hicks [6] independently introduced the concept of duration as a measure of the length of a stream of cash flows and a measure of the elasticity of the present value of the stream with respect to a change in the rate of discount, respectively. Approximately 15 years later, Reddington [8] and Heynes and Kirton [5] used the concept to develop interest rate immunization rules for the portfolio management of insurance companies. More recently, Fisher and Weil [1] have developed duration based rules to help investors find investments that will insure them of having some fixed amount of money available at a specific future point in time. In [2], Grove uses duration to link the investor's decision to speculate or immunize with his subjective forecast of future interest rate movements. Finally, Haugen and Wichern [3, 4] show the relationship between duration and the characteristics of bonds and stocks. Also, in analyzing the effect of financial leverage on interest rate risk, they demonstrate how the financial manager can manipulate the capital structure of his firm, so as to render the present value of the common stock insensitive to changes in the rate of interest.