What is Duration?
Definition
Duration measures a bond's sensitivity to interest rate changes, expressed in years. A duration of 5 means the bond's price will change approximately 5% for every 1% change in interest rates. Longer duration means more interest rate risk.
Detailed Explanation
There are two main types of duration. Macaulay duration is the weighted average time to receive a bond's cash flows. Modified duration adjusts Macaulay duration to show the percentage price change for a 1% change in yield.
Higher duration means greater price sensitivity to rate changes. A bond with a duration of 10 will lose approximately 10% of its value if rates rise 1%, and gain 10% if rates fall 1%. This is why long-term bond funds suffered severe losses during the 2022 rate hiking cycle.
Duration increases with longer maturity, lower coupon rates, and lower yields. A 30-year zero-coupon bond has the highest duration among standard bonds because all cash flow is received at maturity. A short-term bond with a high coupon has lower duration because most value is received through near-term coupons.
Portfolio managers use duration to manage interest rate risk. Shortening portfolio duration (shifting to shorter-term bonds) reduces rate sensitivity. Matching portfolio duration to the investment horizon (immunization) protects against interest rate changes.
Formula
Approximate Price Change = -Duration x Change in Yield x 100%Example
A bond portfolio has a duration of 7 years. If interest rates rise by 0.5%, the portfolio is expected to lose approximately 7 x 0.5% = 3.5% in value. If rates fall by 0.5%, it gains about 3.5%.
Frequently Asked Questions
Is higher or lower duration better?
What is the difference between Macaulay and modified duration?
Does duration apply to bond funds?
Related Terms
Bond
A bond is a fixed-income security where the investor lends money to an issuer (government or corporation) for a defined period at a fixed or variable interest rate. Bonds pay periodic interest (coupons) and return the principal at maturity.
Yield to Maturity (YTM)
Yield to maturity is the total return anticipated on a bond if held until it matures, expressed as an annual percentage. It accounts for the bond's current price, coupon payments, face value, and time to maturity, making it the most comprehensive bond yield measure.
Coupon Rate
The coupon rate is the annual interest rate paid by a bond's issuer relative to the bond's face value. A bond with a $1,000 face value and 5% coupon pays $50 per year in interest, typically in semiannual installments.
Treasury Securities
Treasury securities are debt instruments issued by the US government to fund federal spending. They are considered the safest investments in the world and serve as the benchmark for all other interest rates. Types include bills, notes, and bonds.
See It in Action
Disclaimer: The information on this page is provided for educational and informational purposes only and does not constitute investment advice. AI-generated analysis may contain errors or inaccuracies. Always conduct your own research and consult a qualified financial advisor before making investment decisions.
See Duration in Action
StoxPulse AI automatically tracks and analyzes key financial metrics from earnings calls and SEC filings for your watchlist.