Duration refers to the price sensitivity of a bond, or a portfolio of bonds, to a change in interest rates. It is measured in years.
The higher the duration, the greater the responsiveness of the bond price – or the value of a bond portfolio – to a change in interest rates. There is an inverse relationship between bond prices and interest rates. Expressed differently: the higher the duration of an asset or a portfolio of assets, the higher its interest rate risk.
Typically, for every year of modified duration, a 100 basis point increase (decrease) in interest rates would result in the price of a bond declining (increasing) by about 1%. Thus, for a bond with a duration of 7 years, if interest rates were to increase by 100 basis points, the price of the bond would drop by 7% (that is, 7 years multiplied by 100 basis points).
Duration is affected by the size and timing of future payments on a bond. For example, the longer the maturity of the bond or the bond portfolio, the higher the duration; and, the higher the coupon, the lower the duration.
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