Suppose market yields rise by one percentage point. One bond falls only a little. Another loses well over 10% of its market value. The change in yields is the same, but the price response is not. Why?
The answer is duration. Bond prices and yields move in opposite directions. Duration answers the next question: how much might the price move?
Duration Is More Than Maturity
Maturity tells you when a bond is scheduled to repay its principal. Duration tells you how sensitive its price is to changes in yield. Although both are expressed in years, they are not the same thing.
Consider two bonds that both mature in 10 years. One pays regular coupons; the other is a zero-coupon bond that pays no periodic interest. The zero-coupon bond has higher duration because all of its cash flow arrives at maturity, while the coupon-paying bond delivers some cash earlier.
More generally, for otherwise similar fixed-rate bonds, longer maturity and lower coupons tend to mean higher duration.
Turning Duration Into Price Sensitivity
For estimating price sensitivity, the commonly used measure is modified duration. It gives a practical rule of thumb:
Approximate percentage price change ≈ -Modified duration × Change in yield
Suppose a bond has a modified duration of 6. A 1-percentage-point rise in yield is written as 0.01, so -6 × 0.01 = -0.06. The bond’s price would therefore be expected to fall by roughly 6%. A 1-percentage-point fall in yield would imply an increase of roughly 6%.
Now compare two conventional fixed-rate bonds from the same issuer. Both have a $1,000 face value and a 5% coupon paid semiannually. The main difference is maturity.
| 5-Year Bond | 20-Year Bond | |
|---|---|---|
| Maturity | 5 years | 20 years |
| Approx. modified duration | 4.4 | 12.6 |
| If yield rises by 1 percentage point | Price falls about 4.4% | Price falls about 12.6% |
| If yield falls by 1 percentage point | Price rises about 4.4% | Price rises about 12.6% |
Illustrative modified durations assume a 5% yield to maturity.
What Duration Can and Cannot Tell You
Duration is an approximation, not a forecast. Because the relationship between bond prices and yields is curved rather than perfectly linear, the estimate works best for relatively small yield changes. Duration also changes as time passes and market yields change.
A modified duration of 6 therefore does not promise an exact 6% price move when yields change by one percentage point. It tells you approximately how strongly the bond’s price may respond if yields move, not where yields are going.