Duration Risk
What Is Duration Risk?
Duration risk is the risk that a bond’s price will change significantly due to fluctuations in interest rates. It reflects how sensitive a bond or bond portfolio is to changes in market interest rates.
The longer the bond’s duration, the more sensitive its price is to interest rate movements.
Why It Matters
Understanding duration risk helps investors manage potential losses in fixed-income investments. When interest rates rise, bonds with higher duration typically experience larger price declines.
Managing duration risk is an important part of bond portfolio strategy.
How Duration Risk Works
Bond duration measures the weighted average time investors receive a bond’s cash flows.
Factors that influence duration include:
- bond maturity
- coupon rate
- prevailing interest rates
Long-term bonds generally have higher duration and greater price sensitivity.
Duration Risk vs Interest Rate Risk
- Duration risk measures the degree of sensitivity to interest rate changes.
- Interest rate risk refers broadly to how interest rate changes affect investments.
FAQs About Duration Risk
Why are long-term bonds more sensitive to interest rates?
Because their cash flows occur further in the future.
Can duration risk be reduced?
Yes, through diversification or shorter maturity bonds.
Do bond funds have duration risk?
Yes, bond fund values also respond to interest rate changes.
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