Quick Explainer: Duration

Two bonds can have the same credit quality and still react very differently to the same change in interest rates. The difference often comes down to duration*, a measure of how sensitive a bond’s price is to a rate move. 

Our definition of duration is:

Duration: Measures a bond or bond fund's sensitivity to changes in interest rates, expressed in years. A duration of 5 years implies that a 1% rise in interest rates would cause the price to fall by approximately 5%, and vice versa.

A bond’s maturity is the date its issuer is scheduled to repay the principal, the amount originally borrowed. Duration accounts for the timing of every principal and interest payment, along with factors such as the bond’s yield* and coupon rate, the fixed interest it pays each year as a percentage of its face value.

Longer maturity generally brings higher duration because more of the bond’s cash flows sit further in the future. Coupon payments matter too. A higher coupon returns more cash sooner, which generally lowers duration compared with an otherwise similar bond carrying a lower coupon.

One Rate Move, Two Price Reactions 

Consider two hypothetical bond portfolios. Portfolio A has a duration of 6 years, while Portfolio B has a duration of 14 years. If interest rates rise by 1 percentage point, Portfolio A would be expected to decline by approximately 6%, while Portfolio B would be expected to decline by approximately 14%. If rates fall by 1 percentage point, the approximate movements would reverse.¹ 

These figures are estimates. Duration is most useful for illustrating the effect of a relatively small rate change. Actual results can differ when yields move by larger amounts or when different parts of the yield curve move by different amounts. 

A bond’s fixed payments compete with the yields available on newly issued bonds. When market rates rise, an older bond paying a lower rate becomes less attractive, so its price generally falls. When market rates decline, the existing bond’s fixed payments become more attractive, so its price generally rises.¹ This inverse relationship between bond prices and rates is a form of interest-rate risk, the chance that a bond’s price falls when rates rise.

The further out a payment sits, the more a change in market rates affects what it’s worth today. A bond with a higher duration has more of its value tied up in those later payments, so its price moves more when rates change.

Duration can help investors compare the rate sensitivity of bonds and bond funds with otherwise similar characteristics. A higher-duration portfolio carries greater upside sensitivity when rates fall and greater downside sensitivity when rates rise. A lower duration does not make a bond or bond fund low risk, because credit, inflation, call, and other risks still matter.¹ 

Maturity puts a date on repayment. Duration puts an estimate on rate sensitivity. When two bonds react differently to the same rate move, duration often explains why.