Bond Duration Definition: Interest-Rate Sensitivity Explained
Bond duration measures how sensitive a bond's price is to changes in interest rates. As a rule of thumb, a bond with a duration of 5 loses roughly 5% in price when rates rise 1 percentage point. Longer maturities and lower coupons produce higher duration.
What drives duration
Duration rises with longer maturity and falls with higher coupons, because larger coupon payments return the investor's money sooner. A zero-coupon bond has a duration equal to its maturity, which makes it the most rate-sensitive for its term.
Rates and prices move in opposite directions
When market interest rates rise, existing bond prices fall; when rates fall, prices rise. Duration quantifies the size of that move.
Example
A bond with a duration of 6 would be expected to fall about 6% if interest rates rise by 1 percentage point, and to gain about 6% if they fall by 1 percentage point.
Frequently asked questions
What is Bond Duration?
Bond duration measures how sensitive a bond's price is to changes in interest rates. As a rule of thumb, a bond with a duration of 5 loses roughly 5% in price when rates rise 1 percentage point. Longer maturities and lower coupons produce higher duration.
How does Bond Duration show up on the exam?
When asked which bond is most sensitive to rate changes, pick the longest maturity with the lowest coupon, typically a zero-coupon bond.
Practice this concept
Sources
- FINRA SIE and Series 7 content outlines (debt securities)
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