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How Risky (volatile) is Your Bond Investment?

Bond prices go up and down every day just like stock prices, but for different reasons.

It is important to understand that bond prices move inversely to interest rates.  In other words, if interest rates go up on bonds or bond funds like the one you own, the price of existing bonds go down and vice versa when interest rates go down.  Knowing the “Duration” of your bond or bond mutual fund will tell you how much a change in interest rates should affect the price of your bond investment.


[box]Bond investment duration is an important measure for investors to consider, as bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations.[/box]

Duration of a Vanilla or Straight Bond



Factors Affecting Duration




Duration increases immediately on the day a coupon is paid, but throughout the life of the bond, the duration is continually decreasing as time to the bond’s maturity decreases. The movement of time is represented above as the shortening of the red lever. Notice how the first diagram had five payment periods and the above diagram has only four. This shortening of the time line, however, occurs gradually, and as it does, duration continually decreases. So, in summary, duration is decreasing as time moves closer to maturity, but duration also increases momentarily on the day a coupon is paid and removed from the series of future cash flows – all this occurs until duration, eventually converges with the bond’s maturity. The same is true for a zero-coupon bond

Duration: Other factors


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