How risky are your bonds?

There are two main risks when buying a bond. Matthew Partridge explains what they are, and how “duration” can help tell you if it's a risky bet.

When you buy a bond an IOU from a company or government, in effect one obvious risk is that the borrower will default on its obligations ("credit risk"). That's something you can manage by looking at the creditworthiness of the borrower itself. However, there's another, big-picture risk you also have to consider interest rates. If rates rise, bond prices will tend to fall as yields rise (prices and yields move inversely to one another) in line with the returns available elsewhere. Similarly, falling interest rates will boost bond prices. But how do you measure the risk that rates will change?

That's where "duration" comes in. There are various different types of duration, but put simply, a bond's duration measures how sensitive it is to a change in interest rates. Specifically, it measures the point at which the bond will have paid out half of the present value of all its future cash flows. That might sound complicated, but you don't have to do the sums you can get the figure on plenty of websites.

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Dr Matthew Partridge
Shares editor, MoneyWeek

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri