Duration in Finance: What It Is and Why It Matters for Fixed Income

What Is Duration?

Duration is a measure of a bond's sensitivity to changes in interest rates — specifically, the approximate percentage change in bond price for a 1% (100 basis point) change in yield. It is one of the most important concepts in fixed income portfolio management, risk management, and interest rate hedging.

Macaulay Duration

Macaulay duration is the weighted average time until a bond's cash flows are received, with weights equal to the present value of each cash flow as a proportion of the bond's total price. For a zero-coupon bond, Macaulay duration equals its maturity. For a coupon bond, duration is always less than maturity because earlier coupon payments reduce the weighted average timing of cash flows.

Modified Duration

Modified duration converts Macaulay duration into a direct price sensitivity measure: Modified Duration = Macaulay Duration / (1 + y/n), where y is the yield and n is the compounding frequency. If a bond has a modified duration of 5, a 1% rise in yield will cause approximately a 5% fall in price.

Dollar Duration and DV01

DV01 (Dollar Value of a Basis Point) is the change in bond price for a 1 basis point (0.01%) change in yield: DV01 = Modified Duration × Price × 0.0001. DV01 is widely used in practice for hedging because it expresses interest rate sensitivity in monetary terms rather than percentages.

Duration in Portfolio Management

Portfolio managers use duration to match asset and liability sensitivities (duration matching or immunisation), to take deliberate positions on interest rate direction, and to compare the interest rate risk of different fixed income instruments. Pension funds and insurers in particular manage duration carefully to match long-dated liabilities.

Further Reading

• Treasury Management CPD
• Risk Management Careers
• CPD for Finance Professionals

Study with Learnsignal: CPD for finance professionals in fixed income and risk management. Browse CPD.