Bond duration

Duration is a measure of how long it will take to reach a bond's mid point in cash-flow terms.

Updated August 2018

"Duration" is a measure of risk related to bonds. It describes how sensitive a given bond is to movements in interest rates. Think of the relationship between bond prices and interest rates as being like a seesaw: when one side (interest rates, for example) goes up, the other (in this case, bond prices) goes down.

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Duration (which can be found in the factsheet of most bond funds) tells you the likely percentage change in a bond's price in response to a one percentage point (100 basis points) change in interest rates. The higher the duration, the higher the "interest-rate risk" of the bond that is, the larger the change in price for any given change in interest rates.

Duration also tells you how long (in years) it will take for you to recoup the price you paid for the bond in the form of income from its coupons (interest payments) and the return of the original capital. So if a bond has a duration of ten years, that means you will have to hold on to it for ten years to recoup the original purchase price. It also indicates that a single percentage point rise in interest rates would cause the bond price to fall by 10% (while a single percentage point drop in interest rates would cause the bond price to rise by 10%).

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As a rough guide, the duration of a bond increases along with maturity so the longer a bond has to go until it repays its face value, the longer its duration. Also, the lower the yield on the bond, the higher its duration the longer it takes for you to get paid back. All else being equal, a high-duration bond is riskier (more volatile) than a low-duration bond. For zero-coupon bonds (bonds that don't pay any income at all), the duration is always the remaining time to the bond's maturity.

For interest-paying bonds, duration is always less than its maturity (because you will have made back your original investment at some point before the maturity date).

See Tim Bennett's video tutorial: Bond basics.


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