Duration

Duration is a measure of the sensitivity of a bond’s price to changes in interest rates, expressed in years. It represents the weighted average time until a bond’s cash flows are received. The most common type is Macaulay duration, while modified duration measures the price sensitivity directly. For example, a bond with a duration of 5 years will decrease in value by approximately 5% if interest rates rise by 1%, and increase by 5% if rates fall by 1%. A zero-coupon bond’s duration equals its maturity, while coupon bonds have durations less than their maturity. Duration is crucial for managing interest rate risk in bond portfolios. The higher the duration, the more volatile the bond’s price will be when interest rates change. Portfolio managers often match asset and liability durations to immunize against interest rate risk.