Define duration and why it matters for interest rate risk.

Define duration and why it matters for interest rate risk.

• A. Duration measures a bond's sensitivity to interest rate changes; higher duration means larger price changes for rate moves
• B. Duration equals time to maturity
• C. Duration measures credit risk
• D. Duration is used only for stocks

Answer: (A)

Duration is a measure of how a bond’s price responds to changes in interest rates. It reflects the weighted average time you effectively have to wait to receive cash flows, adjusted for how far those cash flows are in present value terms. The key practical point is that bond prices move inversely to interest rates, and the longer the duration, the larger the price swing for a given rate change. This makes duration a central tool for assessing interest rate risk and for tailoring a portfolio to how sensitive you want it to be to rate moves. It also underpins the rule of thumb that the approximate percentage change in price for small rate moves is about minus duration times the change in yield. Duration isn’t simply time to maturity, because two bonds with the same maturity can have different durations depending on their coupon structure. It also does not measure credit risk, which relates to the issuer’s ability to meet obligations. And it’s not limited to stocks; duration concepts are primarily about fixed income, where interest rate sensitivity is most relevant.

Duration is a measure of how a bond’s price responds to changes in interest rates. It reflects the weighted average time you effectively have to wait to receive cash flows, adjusted for how far those cash flows are in present value terms. The key practical point is that bond prices move inversely to interest rates, and the longer the duration, the larger the price swing for a given rate change. This makes duration a central tool for assessing interest rate risk and for tailoring a portfolio to how sensitive you want it to be to rate moves. It also underpins the rule of thumb that the approximate percentage change in price for small rate moves is about minus duration times the change in yield.

Duration isn’t simply time to maturity, because two bonds with the same maturity can have different durations depending on their coupon structure. It also does not measure credit risk, which relates to the issuer’s ability to meet obligations. And it’s not limited to stocks; duration concepts are primarily about fixed income, where interest rate sensitivity is most relevant.