Duration tells investors the length of time in years
that it will take the bonds cash flows to repay the investor
the price he or she paid for the bond.
A bond duration tells us how much a bonds
price might change when interest rates
change a higher duration number means a
bonds price is more sensitive to
interest rate changes while a lower
duration number means a bonds price is
less sensitive to interest rate changes
this means that the price of a bond with
a duration of five will increase or
decrease by five percent when interest
rates move by one percent a Long's
duration depends on its interest rate
call features yield credit quality and
maturity the shorter the bond term the
lower the duration and vice versa also
the lower the coupon the higher the
duration and vice-versa Christine has a
bond with a 10-year maturity a 0.15
percent yield to maturity a 2.25 percent
annual rate a $1000 par value and
quarterly coupon payments its duration
is nine point one Michael has a similar bond
with a 30-year maturity a zero
point three five percent yield to
maturity a 4.25 percent annual rate a
$1000 par value and quarterly coupon
payments its duration is fifteen point
three two suppose the Federal Reserve
announces changes in its interest rate
policy and interest rates increase
Christine's bond will decrease in value
but Michaels bond will experience a
bigger decrease because of its higher
duration similarly if interest rates were to decrease Michaels bond would
gain more value than christine's again
because of its higher duration duration
is just one factor that affects a Bloods value inflation risk default risk and
call risk are also important but duration tells investors like Christine
and Michael how much risk they face from interest rate changes.