Bond Duration Explained

Duration measures how much a bond's price moves when interest rates change — the single most important number for understanding interest-rate risk.

What duration actually measures

Duration measures a bond's sensitivity to changes in interest rates, expressed roughly in years. It is not the same as maturity, though the two are related — duration accounts for the timing and size of all a bond's cash flows, including coupon payments, not just the date it repays principal. A bond that pays no coupons at all (a zero-coupon bond) has a duration equal to its maturity, since all the value arrives on a single date. A bond that pays regular coupons has a duration shorter than its maturity, because some of the value is returned to the investor earlier, along the way.

Why bond prices move inversely with rates

Bond prices and interest rates move in opposite directions. A bond's coupon payments are fixed when it's issued. If rates in the broader market rise afterward, new bonds get issued paying higher coupons, making the older, lower-coupon bond less attractive by comparison — so its price falls until its effective yield lines up with the new market rate. The reverse happens when rates fall: existing bonds with higher fixed coupons become more valuable, and their prices rise. Duration quantifies exactly how much that price adjustment will be for a given change in rates.

Why longer duration means more sensitivity

The further out a cash flow sits in time, the more its present value is affected by a change in the discount rate. A bond paying off in 30 years has most of its value tied up in payments far in the future, so a shift in rates compounds over a much longer stretch and moves the price sharply. A bond maturing in two years has most of its value returned soon, leaving little time for a rate change to do much damage. That's why long-dated Treasury bonds and long-duration bond funds are far more volatile in price than short-term bills or notes, even though both are backed by the same government.

Modified duration and practical examples

Modified duration converts this sensitivity into a usable estimate: for every 1 percentage point change in interest rates, a bond's price moves approximately the opposite direction by a percentage equal to its modified duration. A bond with a modified duration of 7 would be expected to lose roughly 7% in price if rates rose 1 percentage point, and gain roughly 7% if rates fell by the same amount.

In practice, a short-term Treasury bill with a few months to maturity has a duration near zero and barely reacts to rate changes. A 10-year Treasury note might carry a duration around 8 years. A 30-year Treasury bond can carry a duration near 18-20 years, meaning even a modest rate move can produce a large swing in its price — which is exactly why long-duration bonds are treated as a distinct, higher-risk asset class within fixed income.