Understanding Your Bond Fund’s Duration (2024)

FAQs

Understanding Your Bond Fund’s Duration? ›

The duration of a bond is affected by its coupon rate, yield, and remaining time to maturity. The duration of a bond will be higher the lower its coupon. Duration will be higher the lower its yield. Duration will also be higher the longer its maturity.

How Duration Works in Investing. Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. In general, the higher the duration, the more a bond's price will drop as interest rates rise. This also indicates a higher level of interest rate risk.

Effective duration calculates the expected price decline of a bond when interest rates rise by 1%. The value of the effective duration will always be lower than the maturity of the bond.

Maturity is the time remaining until the bond's principal is repaid. A bond with a 10-year maturity will return the principal to the investor in 10 years. Meanwhile, duration measures a bond's sensitivity to interest rate changes, and reflects the weighted average time it takes to receive all cash flows from the bond.

In the limit, if the bond paid no coupon, its maturity would be equal to its duration, or ten years. That depends on the coupon rate, the remaining time to maturity and the discount rate. For a zero coupon bond the duration of a newly issued 10 year bond is 10 years.

What is a bond's 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.

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.

The bond market is a wide field, with many different categories of assets. In general, you can expect a return of between 4% and 5% if you invest in this market, but it will range based on what you purchase and how long you hold those assets.

The duration formula is a measure of a bond's sensitivity to changes in the interest rate, and it is calculated by dividing the sum product of discounted future cash inflow of the bond and a corresponding number of years by a sum of the discounted future cash inflow.

Bond funds allow you to buy or sell your fund shares each day. In addition, bond funds allow you to automatically reinvest income dividends and to make additional investments at any time. Most bond funds pay regular monthly income, although the amount may vary with market conditions.

Can bond duration be longer than maturity? ›

In Bonds with a negative yield the duration should be longer than the maturity. Duration is the length of time for the return of the fund.

Short-term bonds generally carry less uncertainty because the principal is repaid more quickly and can be reinvested earlier. However, duration is more than just term to maturity. Maturity is simply the number of years left until the bond's principal is repaid.

When interest rates rise, bond prices fall (and vice-versa), with long-maturity bonds most sensitive to rate changes. This is because longer-term bonds have a greater duration than short-term bonds that are closer to maturity and have fewer coupon payments remaining.

The term duration is mathematically defined as the sum of the weighted average time of each of the cash flows that make up a bond. In other words, “pure” duration (denoted in years) is how long it will take for an investor to receive the bond's present value based on the expected future cash flows of the bonds.

If you sell your bonds as soon as someone hints at the word "hike," you may be jumping the gun. When the market consensus is that a rate increase is right around the corner, it's time to sell and reinvest the proceeds in higher-paying bonds. One caveat applies to short-term holdings or those that are near maturity.

Taken together, these provisions allow issuers to make new loans from repayments for 10 years from the date of issuance of the original bond and thereafter, require that repayments of principal be used to redeem bonds. This is commonly referred to as the "10 year rule".

The longer a fund's average effective duration, the more sensitive the fund is to shifts in interest rates. In other words, if rates move up by 1 percentage point, the price of a bond with a duration of 5.0 years will move down by 5%, while a bond with a duration of 10.0 years will move down by about 10%.

Generally, the length of the bond between two atoms is approximately the sum of the covalent radii of the two atoms. Bond length is reported in picometers. Therefore, bond length increases in the following order: triple bond < double bond < single bond.

Macaulay duration measures the weighted average of the time to receive the cash flows from a bond so that the present value of cash flows equals the bond price. A bond's Macaulay duration is positively related to the time to maturity and inversely related to the bond's coupon rate and interest rate.