Term of the Day

duration

  1. The change in the value of a fixed income security that will result from a 1% change in interest rates. Duration is stated in years. For example, a 5 year duration means the bond will decrease in value by 5% if interest ratesrise 1% and increase in value by 5% if interest rates fall 1%. Duration is a weighted measure of the length of time the bond will pay out. Unlikematurity, duration takes into account interest payments that occur throughout the course of holding the bond. Basically, duration is aweighted average of the maturity of all the income streams from a bond orportfolio of bonds. So, for a two-year bond with 4 coupon payments every six months of $50 and a $1000 face value, duration (in years) is 0.5(50/1200) + 1(50/1200)+ 1.5(50/1200)+ 2(50/1200) + 2(1000/1200) = 1.875 years. Notice that the duration on any bond that pays coupons will be less than the maturity because there is some amount of the payments that are going to come before the maturity date. In this example, the maturity was 2 years…
  2. More generally, an interval of time.
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Usage Example
The duration indicator helps explain the interest rate risk on securities, such as bonds.
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