Bond Duration Explainer
Bond duration is a measure related to the timing of a bond’s cash flows and its sensitivity to changes in yield. Macaulay duration is a present-value-weighted average time to receive cash flows. Modified duration converts that timing measure into an approximate percentage price response.
For a small parallel change in yield, a modified duration of five suggests roughly a five percent price move in the opposite direction for a one-percentage-point yield change. The estimate is directional and linear; actual price behavior curves because bonds also have convexity.
Longer maturities and lower coupons generally increase duration because more value arrives later. Higher yields usually reduce it. Floating-rate features, calls, puts, mortgages, and expected prepayments can make cash flows change when rates change, requiring effective rather than simple duration.
Duration does not measure default, liquidity, inflation, currency, or every yield-curve risk. Portfolio managers use it to compare rate exposure and match assets with liabilities, but assumptions should be stress-tested across different curve movements, spreads, and embedded-option behavior.
Duration combines the present-value timing of cash flows with an interest-rate risk estimate.
It is not simply the number of years to maturity.
Modified duration works best for small yield changes.
Convexity and changing cash flows matter for larger moves.
Calls, puts, and prepayments can alter expected payment timing.
Effective duration may be needed when cash flows are rate-dependent.
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