Talk About Duration Duration is a measurement of a bond's interest rate risk that considers a bond's maturity, yield, coupon and call features. These many factors are calculated into one number that measures how sensitive a bond's value may be to interest rate changes. Understanding duration A bond's price moves in the opposite direction of its yield, as illustrated in the chart below. This inverse relationship between price and yield is crucial to understanding value in bonds. Another key is knowing how much a bond's price will move when interest rates change. To estimate how sensitive a particular bond's price is to interest rate movements, the bond market uses a measure known as duration. Expressed in years, duration is the weighted average of the present value of a bond's cash flows, which include a series of regular coupon payments followed by a much larger payment when the bond matures and the face value is repaid. Download Chart How investors use duration to gauge interest rate sensitivity Generally, the higher a bond's duration, the more its value will fall as interest rates rise, because when rates go up, bond values fall and vice versa. If an investor expects interest rates to fall during the course of the time the bond is held, a bond with a longer duration would be appealing because the bond's value would increase more than comparable bonds with shorter durations. As the table to the right shows, the shorter a bond's duration, the less volatile it is likely to be. For example, a bond with a one-year duration would only lose 1% in value if rates were to rise by 1%. In contrast, a bond with a duration of 10 years would lose 10% if rates were to rise by that same 1%. Conversely, if rates fell by 1%, bonds with a longer duration would gain more, while those with a shorter duration would gain less. Download Chart How active managers use duration While duration does have limitations, it can be an extremely useful tool for building bond portfolios and managing risk. As a portfolio manager's interest rate outlook changes, he or she can adjust the portfolio's average duration (by adjusting the holdings in the portfolio) to coincide with the forecast. In contrast, passive bond strategies that hew to an index, such as the Bloomberg Barclays U.S. Aggregate index, which is a proxy for the bond market in the U.S., are forced to assume the duration and subsequent interest rate risk of that index. In the case of the Bloomberg Barclays U.S. Aggregate, shown in the chart to the right, duration has increased materially in the last eight years – and may be slower to change than a bond strategy that is actively managed. Download Chart More on Duration Section: Tag: Date: Expert: Ticker: Reset All Viewpoints Bonds Are Different The case for active management in fixed income investing is strong. Smart Charts Access our library of economic and market charts that you can download, save and share. Investment Education Get to know the essentials for making intelligent investment decisions with our education series covering a range of themes from financial fundamentals to the intricacies of sophisticated risk management, global investment strategies and macroeconomic trends.