Question

What is duration of bond? Why is it important?

Answer 1

Duration of a bond is the time period it requires to repay the investment. Duration is expressed in number of years and evaluates responsiveness of the price of investment when interest rate changes.

Duration is used to look over and compare sensitivity of different bond options with respect to change in yield rate. Price of a bond is inversely related to its yield rate. On raising the yield, bond price falls and vice versa. Duration is related to both the parameters as:

-?P = ?r x duration

Where ?P is the change in price and ?r is the change in yield rate.

Hence duration is capable to show the sensitivity of bond or bond portfolio in the environment of different interest rate. It can guide investors in comparing various funds with greater or lower sensitivity to interest rate in order to access the volatility of the portfolio and also indicate the weighted average timing of cash flow of all the bonds in the portfolio.