What is duration?
Duration is a measure of how sensitive the price of a bond is to changes in interest rates.
It estimates how much a bond’s price is likely to move for a given change in rates and reflects the timing of the bond’s cash flows.
In simple terms, duration shows how much a bond’s price may change when interest rates move.
How duration works
Duration is expressed in years, but it is really a sensitivity figure. A bond with a duration of five years would be expected to fall by roughly five per cent in price if interest rates rose by one percentage point, and to rise by a similar amount if rates fell. Bonds with longer maturities and lower coupons generally have higher duration and so react more to rate changes.
What affects a bond’s duration
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Time to maturity, with longer bonds having higher duration
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The size of the coupon, with lower coupons raising duration
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The level of interest rates
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Whether the bond has special features, such as early repayment
Short compared with long duration
| Feature |
Short duration |
Long duration |
| Rate sensitivity |
Lower |
Higher |
| Price swings |
Smaller |
Larger |
| Typical maturity |
Shorter |
Longer |
What lengthens or shortens duration
A bond’s duration depends on several features. Longer time to maturity generally increases duration, since more future payments are exposed to rate changes. A lower coupon also lengthens duration, because more of the bond’s value sits further in the future. Higher coupons and shorter maturities shorten it. Understanding these drivers helps investors judge how much a bond, or a bond portfolio, might move as interest rates change, which is central to managing interest-rate risk. Duration is also useful at the portfolio level, where the combined figure shows how sensitive a whole bond holding is to rate moves. Investors expecting rates to rise may favour shorter-duration bonds to limit price falls, while those expecting cuts may accept longer duration for greater potential price gains.
Duration and interest-rate risk
Duration is an estimate based on small rate changes and becomes less precise for large moves, where a related measure called convexity is used. It also does not capture credit risk, which is the chance that an issuer fails to pay. Traders use duration to gauge interest-rate risk, but they consider it alongside other factors rather than in isolation.
Working through duration
Say a bond has a duration of five years. If interest rates rose by one percentage point, its price would be expected to fall by roughly five percent, and to rise by a similar amount if rates fell. Duration therefore gives a simple gauge of how sensitive the bond is to rate changes.
How duration affects price sensitivity
Duration is a key tool for understanding how bonds respond to changing interest rates, which is central to fixed-income trading. Grasping it helps traders judge interest-rate risk and compare bonds more effectively, while keeping in mind that bond prices can move against them and that all trading carries risk.
Risk Warning:Trading CFDs involves significant risk and may not be suitable for all investors. Losses can exceed your initial deposit. Please ensure you fully understand the risks involved before trading.
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