Duration is a financial metric used to gauge the sensitivity of a bond or another debt instrument’s price to fluctuations in interest rates. It quantifies the potential impact of interest rate changes on the bond’s value. Duration is often expressed in years, which can sometimes be mistaken for the bond’s term or time to maturity.
A bond’s duration reflects how long it will take for an investor to recoup the bond’s price through its expected cash flows, including coupon payments and the return of principal at maturity. Bonds with longer durations are typically more sensitive to interest rate changes, meaning their prices are likely to fluctuate more in response to shifts in market interest rates. Duration is a crucial tool for fixed-income investors and portfolio managers as it helps them assess and manage interest rate risk within their bond portfolios.