Bond Duration
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INTEREST RATE MOVEMENTS AND BOND VALUES
What is it?
Duration functions as a tool to determine the volatility of a bond's value with changes in interest rates. Most people know that the value of a bond is more volatile with interest rates the longer the maturity of the bond. Therefore, longer maturity bonds exhibit a higher degree of value at risk compared to short-term bonds.
How it works?
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For working purposes, duration can be defined as the percentage change |
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in bond value for a 1% change in interest rates. For example, a duration |
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1.95%, means the value of the bond will change by $19.50 ($1,000 X |
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1.95%). Bond values move inverse to changes in interest rates. |
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(see illustration below for further examples)
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Interest rate movements and bond value |
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Bond A |
Bond B |
Bond C |
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2-year |
10-year |
30-year |
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Duration |
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1.95% |
8.02% |
13.96% |
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Bonds A, B, and C |
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$1,000 |
$1,000 |
$1,000 |
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are priced at $1,000 |
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If interest rate rise by 1% |
$980.50 |
$919.80 |
$860.40 |
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If interest rates fall by 1% |
$1,020 |
$1,080 |
$1,140 |
Key Points:
Bond prices increase when interest rates fall and vice versa
Longer maturity bonds are more sensitive to changes in interest rates
Longer maturity bonds exhibit risk levels comparable to equity securities
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