Bond Duration
Duration is an indicator of a bond’s price sensitivity to relatively small interest rate changes. A bond’s duration expresses the percentage change in the price of a bond that would result from a 1% change in yield. A bond with a high duration is more sensitive to interest rate changes than a bond with a low duration. If a bond has a duration of 5, its price will decrease 5% with a 1% increase in interest rates, while a bond’s price will decrease 10% if it has a duration of 10. Duration measures the risk of interest rate volatility.
Two factors influence a bond’s interest rate volatility: the coupon rate and the time to maturity. A high coupon rate generates high annual interest payments. A 1% change of a high interest rate will change the value of that payment more than the same change for a low interest rate. Similarly, a 1% change will have a greater impact on a bond that matures in 16 years than one that matures in two years because the impact of that 1% change will grow as it compounds over time. Duration allows investors to compare the interest rate risk between bonds having different issue and maturity dates, coupon rates, and yields to maturity.
Note: A zero coupon