Investopedia Video: The Basics Of Bond Duration

Duration tells investors the length of time, in years, that it will take a bond's cash flows to repay the investor the price he or she paid for the bond. A bond's duration also tells investors how much a bond's price might change when interest rates change i.e. how much risk they face from interest rate changes.

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.