Duration measures the sensitivity of a bond's price to changes in interest rates. It is expressed in years and indicates how long it takes for the price of a bond to be repaid by its internal cash flows.
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Duration is higher for bonds with longer maturities.
Lower coupon rates result in higher duration.
Zero-coupon bonds have durations equal to their maturity.
Duration helps assess interest rate risk.
Modified duration adjusts Macaulay duration for changes in yield.
Review Questions
How does an increase in interest rates affect a bond's duration?
Why do zero-coupon bonds have durations equal to their maturity?
What is the relationship between coupon rates and duration?
Related terms
Macaulay Duration: The weighted average time until a bond's cash flows are received, measured in years.
Modified Duration: Adjusts Macaulay duration to estimate the percentage price change of a bond for a given change in yield.
Convexity: Measures the curvature or the degree of the curve in the relationship between bond prices and yields, improving accuracy over duration alone.