Bond Maturity and Duration

Bond Maturity and Duration

What the heck does "duration" mean?

Why a bond's duration is as important, or more important, as it's maturity

What the heck does "duration" mean?

A bond's maturity show's when you'll be paid the bond's face value

Duration is a weighted measure of when you'll get your money back from a bond investment

Duration considers coupon payments

The duration of a zero-coupon bond equals the bond's maturity

For two bonds that mature at the same time

The bond with the ^higher coupon payment has the _lower duration

Example

• Newly issued bond which makes semiannual coupon payments
• Market interest rates for this bond demand 8 percent interest
• The bond makes a final repayment of $1,000 after 10 years

Annual coupon rate	Semiannual coupon payment	Bond value	Bond duration
0%	$0	$456	10 years
6	30	864	7.45
8	40	1,000	7.07
10	50	1,135	6.77

Why a bond's duration is as important, or more important, as it's maturity

The duration of a bond reflects the interest rate risk in the bond

Bonds with higher durations face higher interest rate risk

See how the same bond illustrated above reacts to different interest rates

• Newly issued bond which makes semiannual coupon payments
• Market interest rates for this bond demand 8 percent interest
• The bond makes a final repayment of $1,000 after 10 years

Annual coupon rate	Bond duration	Market rates drop to 7 percent		Initial price at 8 percent market rate	Market rates rise to 9 percent
		Bond price	Change in price		Bond price	Change in Price
0%	10 years	$503	10.3%	$456	$414	-9.2%
6	7.45	929	7.5	864	805	-6.8
8	7.07	1,071	7.1	1,000	935	-6.5
10	6.77	1,213	6.9	1,135	1,065	-6.2

In the above table, bonds with higher durations had a bigger loss when interest rates rose

Similarly, bonds with higher durations had a bigger gain when interest rates fell

Here's a good rule of thumb regarding interest rate risk

When interest rates rise one percent, the percentage loss in a bond's value equals the bond's duration

The same holds true for appreciation in a bond's price when interest rates fall

Bond duration	Change in bond price
	Rates fall 1 percent	Rates rise 1 percent
1 year	1%	-1%
3	3	-3
10	10	-10

This underscores the fact that long-term bonds are much riskier with respect to interest rate risk than short-term bonds