What is Duration?
Duration is the key risk metric for bonds. It answers the critical question: how much will my bond's value change if interest rates move? Higher duration means more volatility — both opportunity and risk.
Duration measures a bond's price sensitivity to interest rate changes. It tells you approximately how much a bond's price will change when yields move by 1%. A duration of 7 means a 1% rate increase causes roughly a 7% price drop.
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Macaulay Duration
Macaulay duration is the weighted-average time to receive all cash flows, measured in years. It tells you the bond's 'effective maturity' considering all coupon payments. A zero-coupon bond's duration equals its maturity; coupon-paying bonds have duration less than maturity.
Modified Duration
Modified duration = Macaulay duration ÷ (1 + yield). It directly estimates percentage price change: Price change ≈ -Modified duration × Yield change. This is the number most investors use.
What Affects Duration
Three factors increase duration: (1) Longer maturity; (2) Lower coupon rate; (3) Lower yield. A 30-year zero-coupon bond has very high duration (30 years); a 2-year bond with 5% coupon has low duration (~1.9 years).
Duration of German Federal Securities
| Security | Typical Maturity | Approximate Duration |
|---|---|---|
| Bubill | 3-12 months | 0.25-1 year |
| Schatz | 2 years | ~1.9 years |
| Bobl | 5 years | ~4.5 years |
| Bund (10Y) | 10 years | ~8.5 years |
| Bund (30Y) | 30 years | ~20 years |
Practical Example: Duration in Action
You hold a 10-year Bund with modified duration of 8.5. The ECB raises rates by 0.5%. Expected price change: -8.5 × 0.5% = -4.25%. Your €10,000 investment drops to about €9,575. Conversely, if rates fall 0.5%, your bond gains €425.
Frequently Asked Questions
What is duration in simple terms?
Duration tells you how much your bond's price will move when interest rates change. Higher duration = more price movement = more risk (and potential reward).
Is higher duration good or bad?
Neither — it depends on your view. If you expect rates to fall, high duration magnifies gains. If rates rise, high duration magnifies losses. Match duration to your risk tolerance.
How do I reduce duration risk?
Buy shorter-maturity bonds or bonds with higher coupons. You can also ladder maturities (spread investments across different terms) to average out duration.
Why is duration different from maturity?
Maturity is when you get your principal back. Duration accounts for all cash flows (coupons too). A bond paying big coupons returns your money faster, so duration < maturity.
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