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Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. A bond's duration is easily confused with its term or time to maturity because certain types of duration measurements are also calculated in years.
However, a bond's term is a linear measure of the years until repayment of principal is due; it does not change with the interest rate environment. Duration, on the other hand, is non-linear and accelerates as the time to maturity lessens. Duration can also measure the sensitivity of a bond's or fixed income portfolio's price to changes in interest rates.
In general, the higher the duration, the more a bond's price will drop as interest rates rise and the greater the interest rate risk. The duration of a bond in practice can refer to two different things. The Macaulay duration is the weighted average time until all the bond's cash flows are paid. By accounting for the present value of future bond payments, the Macaulay duration helps an investor evaluate and compare bonds independent of their term or time to maturity.
The second type of duration is called modified duration. Unlike Macaulay's duration, modified duration is not measured in years. In order to understand modified duration, keep in mind that bond prices are said to have an inverse relationship with interest rates. Therefore, rising interest rates indicate that bond prices are likely to fall, while declining interest rates indicate that bond prices are likely to rise.
Macaulay duration finds the present value of a bond's future coupon payments and maturity value. Fortunately for investors, this measure is a standard data point in most bond searching and analysis software tools. Because Macaulay duration is a partial function of the time to maturity, the greater the duration, the greater the interest-rate risk or reward for bond prices. Macaulay duration can be calculated manually as follows:. The previous formula is divided into two sections.
The first part is used to find the present value of all future bond cash flows. The second part finds the weighted average time until those cash flows are paid. Post by dbr » Fri Jun 19, pm.
Post by kolea » Fri Jun 19, pm. Post by Northern Flicker » Fri Jun 19, pm. Post by grabiner » Sat Jun 20, am. Post by LadyGeek » Sat Jun 20, am. Post by grabiner » Sat Jun 20, pm. Privacy Terms. Time: 0. Quick links. Duration - why is it expressed in years? Discuss all general i. Investors who are more comfortable with these fluctuations, or who are confident that interest rates will fall, should look for a longer duration.
While duration can be an extremely useful analytical tool, it is not a complete measure of bond risk. For example, duration does not tell you anything about the credit quality of a bond or bond strategy. This can be particularly important with lower-rated securities such as high yield bonds , which tend to react as much, if not more, to investor concerns about the stability of the issuing company as they do to changes in interest rates.
Another limitation to using duration when evaluating a bond strategy is that its average duration may change as the bonds within the portfolio mature and interest rates change.
While duration does have limitations, it can be an extremely useful tool for building bond portfolios and managing risk. These adjustments can be made either for the portfolio as a whole or for a particular sector within the portfolio. So, if the manager expects interest rates to fall, the average duration of the portfolio could be lengthened in order to get the maximum benefit from the change.
A portfolio with a negative duration will increase in value when interest rates rise, barring other impacts. Because interest rate expectations have a significant impact on bond values, PIMCO devotes considerable effort trying to anticipate global economic and political trends that may influence the direction of interest rates.
That long-term outlook is then translated into a general duration range for our portfolios, with short-term adjustments made, as necessary, within that range.
In addition to interest rates, we also apply duration measurements to determine bond value sensitivity to shifts in other factors, such as yield curve and bond spreads. Fixed income investors have long benefited from a flexible approach, which today may be especially valuable in helping combat current market challenges and further enhancing the diversification potential of bonds. Learn key insights from our recent Cyclical Forum, including our outlook on policy, inflation and growth, and how investors can navigate the challenges and opportunities ahead.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk.
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