BROWSE

Duration

Let us take bonds as our fixed-income investment to help you understand the concept of duration.

When we talk about duration, we are talking about the length of time it will take for the cash flows of the bond to pay back the investor. In simpler terms, the duration of a bond is an indicator of the effects that a change in interest rates will have at that particular bond. For instance if a bond has a duration of fifteen eight years, it determines that a change in interest rates will have a great impact on the price of that bond.

This can either be good or bad depending upon whether the interest rates have increased or decreased. If the rate of interest increases, the price of a bond with greater duration will fall greatly as compared to the one with a smaller duration. Similarly, if the interest rate decreases, the price of a bond with shorter duration will have a slight increase in price as compared to the one with greater duration – which will have a greater increase in price.

Put in simpler terms, an increase in interest rate decreases the price of the bond and vice versa. However, this increase or decrease depends vastly upon the duration of that bond. The greater the duration, the greater will be the change in the price.

A common example

A common example to understand duration and its effects is the five-year example. Consider yourself investing in a five-year fixed-investment. In this case, a one percent rise in the interest rates will trigger a five percent decrease in the price of the investment, whereas a one percent fall in interest rates will feature a five percent increase in the price of that investment.

Duration and coupon rate

The duration of a bond also depends upon its coupon rate. Just like the interest rate, the coupon rate also has an inverse relation with the duration of the investment. It means that a higher coupon rate will result in a shorter duration of the bond and vice versa.

Other factors affecting Duration

Apart from the interest and coupon rates, the duration of a fixed-payment investment also depends upon the following:

  • Yield to maturity
  • Call features
  • Credit quality

Other factors affecting price of the bond

The value of a bond also depends upon several factors other than duration and interest rates. These factors include:

  • Inflation risk
  • Call risk
  • Default risk

Although there are many factors that determine the value of a fixed-income investment, the duration of a bond is one of the most vital factors that investors take into account while investing their money.


Further Reading


Hazard‐based duration models and their application to transport analysis
www.tandfonline.com [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

Influence of debt financing on the effectiveness of the finite duration investment projectInfluence of debt financing on the effectiveness of the finite duration investment project
www.tandfonline.com [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

Duration dependence testing for speculative bubblesDuration dependence testing for speculative bubbles
link.springer.com [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

The duration of bank relationshipsThe duration of bank relationships
www.sciencedirect.com [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

Bank valuation with an application to the implicit duration of non-maturing depositsBank valuation with an application to the implicit duration of non-maturing deposits
www.inderscienceonline.com [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

Comparison between Concepts of Non-governmental Lending and Finance: Based on Duration Analysis on Theories <span style=[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-FCGY201302004.htm' />Comparison between Concepts of Non-governmental Lending and Finance: Based on Duration Analysis on Theories [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-FCGY201302004.htm'>PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

Business cycle turning points, a new coincident index, and tests of duration dependence based on a dynamic factor model with regime switchingBusiness cycle turning points, a new coincident index, and tests of duration dependence based on a dynamic factor model with regime switching
www.mitpressjournals.org [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

Statistical Time to Event Analysis in the Social Sciences: Modeling Hazard Rate and Duration in Finance.Statistical Time to Event Analysis in the Social Sciences: Modeling Hazard Rate and Duration in Finance.
psycnet.apa.org [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …

The effect of unemployment insurance on unemployment durationThe effect of unemployment insurance on unemployment duration
www.journals.uchicago.edu [PDF]
… is used. Hazard‐based duration models, which have enjoyed widespread use in a number of non‐transport fields (eg economics, biostatistics), are an obvious choice for modelling such transport phenomena. The objective of …



FAQ


What is duration?

Duration is a measure of the sensitivity of a bond's price to changes in interest rates.

What does duration tell you about how much a bond's price will change for every percentage point change in interest rates?

It tells you that for every one percent increase in interest rates, the bond's price will decrease by approximately "duration" percent.

How do you calculate duration?

You can use the following formula to calculate duration.

How do you interpret the result from this calculation?

The result shows how much a bond's value will fall if interest rates rise by one percentage point. For example, if your calculation shows that your bond has a duration of 5 years, and interest rates rise by one percentage point, then your bond would be worth approximately five percent less than it was before the rate hike.

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