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Bond investors often talk about duration and maturity of bonds when evaluating a single bond or a bond portfolio. Generally speaking, duration and maturity are two key concepts in bond investing which refer to different aspects of a bond’s timeline and sensitivity to interest rate changes. With regard to this, it is worthwhile to look more closely at these two measures.
Duration
The duration is a measure for the sensitivity of a bond (portfolio) to interest rate changes. It represents the weighted average time it takes for an investor to receive all the cash flows (interest payments and principal repayment) from the bond. As a result, the duration of a bond is shorter than its maturity. The only exception from this rule are zero-coupon bonds. Since zero-coupon bonds have no interest payments, their duration equals their maturity.This means the duration is a useful measure to assess the interest rate risk of a bond (portfolio), as it estimates how much the bond’s price will fluctuate if interest rates change. A bond with a higher duration is more sensitive to interest rate changes than a bond with a lower duration. For example, if a bond has a duration of five years, its price will decrease approximately 5% if interest rates increase by 1%, and vice versa. Therefore, the duration is a risk measure, which can be used to evaluate if a bond (portfolio) fits the risk bearing capacity of an investor.There are different types of duration used by investors. The most common measure is Macaulay duration, which is the weighted average time until cash flows are received, measured in years. Another common measure is modified duration, which directly estimates the bond’s price sensitivity to interest rate changes.
Maturity
The maturity is the time remaining until the principal of a bond (face value) is repaid in full to the bondholder. This means, for example, that a 10-year bond which is issued today has a maturity of 10 years.This means the maturity tells investors how long they will be earning interest and when they’ll receive the principal back. This enables bond investors to plan reinvestments ahead of time and allows them to compare their bond (portfolio) with other bonds with the same maturity and/or evaluate their positioning on the respective yield curve. The maturity of a bond (portfolio) can be trimmed in one or the other direction by using derivatives.Investors can use the maturity to steer the positioning of their bond portfolio on the yield curve and evaluate the yield of their bond (portfolio), since bonds with longer maturities should pay higher interest rates to compensate the investor for the greater uncertainty over a longer period. The latter is obviously not true in times of inverted yield curves.
Summary Duration and Maturity
When it comes to duration and maturity, it can be concluded that the maturity is about the timeline for the return of principal, while duration is about interest rate sensitivity. In other words, maturity tells you when a bond ends, while duration tells you how much the bond’s price is likely to move with changes in interest rates.This means, that duration and maturity play a key role when an investor is defining the of a portfolio, as the implied of bonds with a long maturity—and a respective long duration—might be above the .More By This Author:
Duration And Maturity – What Are The Differences And How Can They Be Used By Investors?
