Glossary · UK
What is Duration (Bonds)?
A measure of how sensitive a bond's price is to changes in interest rates, expressed roughly as the number of years to recover its cost through cash flows.
Full Definition
Duration is a measure used to estimate how sensitive a bond's market price is to changes in interest rates, expressed in years and reflecting the weighted average time it takes for an investor to receive the bond's cash flows (coupon payments and the final repayment of the principal), each weighted by its present value. As a rule of thumb, a bond with a duration of, say, seven years will see its price move by roughly 7% for each one-percentage-point change in prevailing interest rates -- rising when rates fall and falling when rates rise -- so a higher duration means greater price sensitivity to interest rate movements, and therefore greater risk (and potential reward) from rate changes. Duration is generally longer for bonds with a longer time to maturity and for bonds with lower coupon rates (since more of their total return is concentrated in the final repayment of principal rather than spread across regular coupon payments), while shorter-dated or higher-coupon bonds tend to have lower duration and are therefore less sensitive to rate changes. Fund factsheets for bond funds routinely quote an average duration figure, which investors and advisers use to judge how much interest rate risk a fund is taking on and to compare funds with similar strategies, alongside separately considering credit risk (the risk that a bond issuer fails to pay) and reinvestment risk.