Duration
The present-value-weighted average time until a bond's cash flows are received (Macaulay duration), and by extension the measure of how much its price moves when yields change. Modified duration is Macaulay duration divided by one plus the yield.
Example
A 5-year bond with a 4% coupon at a 4% yield has a Macaulay duration of 4.6299 years and a modified duration of 4.4518, so a 100 basis point rise implies a price fall of about 4.45%.
Important
It is a sensitivity measure, not a forecast. Choosing a duration because of where you think rates are going converts a risk measure into a bet, and the estimate itself drifts on moves larger than about a hundred basis points.
Related terms
- Convexity — The curvature of the relationship between a bond's price and its yield. Because the relationship is a curve and modified duration is a straight line tangent to it, the duration estimate is imprecise, and increasingly so as the move grows.
- Interest-rate risk — The risk that prevailing yields move and reprice a bond you already hold, because its fixed coupon must now compete with newly issued bonds paying a different rate.
- Maturity — The date on which a bond repays its par value and the contract ends. Bonds are commonly grouped as short, intermediate or long by how far away that date is.
- Basis point — One hundredth of a percentage point. A move from 4.00% to 4.25% is 25 basis points; a move from 4.00% to 6.00% is 200.
Lessons that explain it
All 578 terms in the Investing glossary