10.c Duration Defined

Duration

A measure of the change in a bond's price for a given change in interest rates, indicating how sensitive a bond is to interest rate movements.

Maturity vs. Duration

Maturity is the length of time until a bond's principal is repaid, while duration is the weighted average time until all cash flows from the bond are received.

Reinvestment Risk

The risk of having to reinvest cash flows at lower interest rates when the maturity of a security is less than the investment horizon.

Price Risk

The risk that the price of a bond will decrease when interest rates rise, particularly when the bond's maturity is greater than the investment horizon.

Immunization

A strategy that matches the duration of a bond to the investment horizon to eliminate interest rate risk.

Zero-Coupon Bond

A bond that pays no annual interest; its duration equals its maturity since all cash flows occur at maturity.

Horizon Period

The time frame until the invested money is needed, guiding investment decisions regarding duration and maturity.

Cash Flow Timing

The schedule of when cash flows will be received, which affects the calculation of duration.

Coupon Bond

A bond that pays interest (coupons) periodically until maturity, with its duration being less than its maturity.

Weighted Average

A calculation that takes into account the varying degrees of importance of the cash flows when determining duration.