Bond Duration
A measure of a bond's price sensitivity to interest rate changes, expressed in years.
What is Bond Duration?
Bond duration is a measure of how sensitive a bond's price is to changes in interest rates. Macaulay duration represents the weighted average time (in years) to receive a bond's cash flows; modified duration measures the percentage price change for a 1% change in yield. A bond with a modified duration of 5 will decline approximately 5% in price for every 1% rise in interest rates, and rise approximately 5% for every 1% fall. Duration increases with maturity and decreases with coupon rate — zero-coupon bonds have duration equal to their maturity. Duration is the primary tool for managing interest rate risk in fixed-income portfolios.
Example
A bond with a modified duration of 7 years is priced at $1,000. Interest rates rise by 1%: the bond's price falls approximately 7% to $930. If rates rise by 2%, the price falls roughly 14% to $860. A bond fund manager who expects rising rates will shorten portfolio duration (sell long-term bonds, buy short-term bonds) to reduce this price sensitivity.