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Introduction If you’ve ever wondered why bond prices fall when interest rates rise, duration is the answer. Duration measures a bond’s sensitivity to changes in interest rates. It is one of the most critical concepts for fixed-income investors, yet it is often misunderstood or overlooked. This post explains duration in a practical, example-rich, and actionable way.

1. Defining Bond Duration Duration tells you how much a bond’s price is likely to change when interest rates move by 1%. It is expressed in years, but it’s not the same as a bond’s maturity.

2. Types of Duration

• Macaulay Duration: Measures the weighted average time to receive the bond’s cash flows.
• Modified Duration: Adjusts Macaulay duration to reflect price sensitivity to interest rate changes.
• Effective Duration: Used for bonds with embedded options like callable or putable bonds.

3. Duration vs. Maturity A common misconception is that a bond’s duration equals its maturity. This isn’t always true. A 10-year bond may have a duration of 8.5 years if it pays semi-annual coupons.

4. Why Duration Matters

• Helps manage interest rate risk
• Essential for immunizing a portfolio
• Crucial in performance attribution analysis for fund managers

5. Real-World Example: 2022 Rate Hikes When the Federal Reserve raised rates aggressively in 2022, long-duration Treasury bonds saw steep losses. TLT, a popular ETF holding long-term Treasuries, dropped by over 30%.

6. Duration and Bond Prices

• A bond with a duration of 7 years will lose approximately 7% in value if interest rates rise by 1%.
• Conversely, it will gain about 7% if rates fall by 1%.

7. Portfolio Applications

• Match duration to investment horizon
• Use barbell and ladder strategies to manage risk
• Adjust duration based on interest rate outlook

8. Duration and Convexity Convexity measures how the duration of a bond changes as interest rates change. It improves accuracy in predicting price changes and is especially important for large interest rate shifts.

9. Institutional Use Pension funds, insurance companies, and asset managers use duration for liability matching and capital efficiency.

10. Tools to Calculate Duration

• Bloomberg Terminal
• Bond calculators
• Excel formulas using cash flow models

Conclusion Duration is the language of risk in the bond market. Whether you’re a seasoned investor or just starting, understanding how duration impacts your portfolio will make you a more informed and confident financial decision-maker.