Duration
Quick Definition
A measure of a bond's price sensitivity to interest rate changes, expressed in years, indicating how much the price will move for a 1% change in rates.
What Is Duration?
Duration is the most important risk metric in fixed income investing, measuring a bond's sensitivity to interest rate changes. Technically, Macaulay duration is the weighted average time until a bond's cash flows are received, expressed in years. Modified duration converts this into price sensitivity: a bond with 5 years modified duration will lose approximately 5% of its value if interest rates rise by 1%, or gain 5% if rates fall by 1%. Longer-maturity bonds have higher duration, as do bonds with lower coupon rates (more of the value comes from the distant par payment). A 30-year Treasury bond might have duration around 18-20 years, while a 2-year note has duration close to 2 years. Zero-coupon bonds have the highest duration of all, as their Macaulay duration equals their maturity. Duration is the cornerstone of interest rate risk management — portfolio managers match or adjust duration to control their exposure to rate movements. Dollar duration measures the dollar value change per basis point.
Duration Example
- 1A bond fund with 6-year duration loses approximately 6% when rates rise 1% — a $100,000 portfolio drops to $94,000
- 2A 30-year zero-coupon Treasury has duration of 30 years — the most rate-sensitive bond possible, gaining or losing 30% per 1% rate change
Related Terms
Modified Duration
A measure of a bond's price sensitivity to interest rate changes, expressed as the approximate percentage price change for a 1% change in yield.
Convexity
A measure of the curvature in the relationship between bond prices and yields, indicating how duration changes as interest rates move.
Duration Risk
The risk that changes in interest rates will cause significant fluctuations in bond prices, with longer-duration bonds facing greater price volatility.
Yield to Maturity (YTM)
The total annualized return an investor earns if a bond is held until maturity, accounting for coupon payments, purchase price, and par value at redemption.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
Treasury Bond (T-Bond)
A long-term U.S. government debt security with a maturity of 20 or 30 years, paying semiannual coupon interest.
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