Coupon rate and duration relationship

Another risk that bond investors face is interest rate risk--the risk that rising interest rates will make their fixed interest rate bonds less valuable. A bond's duration will determine how its price is affected by interest rate changes. The reverse is also true. Comparatively, your bond is now much more attractive.

An Introduction to Duration

Another risk that bond investors face is interest rate risk--the risk that rising interest rates will make their fixed interest rate bonds less valuable. A bond's duration will determine how its price is affected by interest rate changes.

The reverse is also true. Comparatively, your bond is now much more attractive. Duration is the tool that helps investors gauge these price fluctuations that are due to interest rate risk. Duration is expressed as a number of years from the purchase date. In simple terms, a bond's duration will determine how its price is affected by interest rate changes. You will notice that all components of a bond are duration variables. That is, the bond's duration, coupon, and yield-to-maturity, as well as the extent of the change in interest rates, are all significant variables that ultimately determine how much a bond's price moves.

Bond Values, Rates, and Maturity. Bond Duration Defined. Properties of Bond Duration. Duration and Bond Interest Rate Risk. Duration Is a Guide to Selecting Bonds.

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Duration is a linear approximation of a nonlinear relationship. Duration is affected by the bond's coupon rate, yield to maturity, and the amount of time to. A bond's coupon rate is a key factor in calculation duration. mind that bond prices are said to have an inverse relationship with interest rates.

Bond prices change inversely with interest rates, and, hence, there is interest rate risk with bonds. One method of measuring interest rate risk due to changes in market interest rates is by the full valuation approach , which simply calculates what bond prices will be if the interest rate changed by specific amounts. The full valuation approach is based on the fact that the price of a bond is equal to the sum of the present value of each coupon payment plus the present value of the principal payment. That the present value of a future payment depends on the interest rate is what causes bond prices to vary with the interest rate, as well.

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Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. A bond's duration is easily confused with its term or time to maturity because they are both measured in years. However, a bond's term is a linear measure of the years until repayment of principal is due; it does not change with the interest rate environment.

Understanding Fixed-Income Risk and Return

Duration is a measure of interest-rate risk. Or, stated differently, duration is a measure of how sensitive the price of a fixed-income instrument is to interest-rate changes. Duration can be thought of as the weighted average of when the bondholder receives payment. Check that the way the weights react is consistent with the relationships on the previous slide. With the following app, you can set the maximum yield-to-maturity, and time to maturity, and see the resulting 3D duration surface.

When you read reports on bonds and bond mutual funds, you will likely come across two apparently similar terms — bond maturity and bond duration. Though related, they refer to two different concepts. As an educated investor, you need to understand these concepts in order to make wise investment decisions regarding bonds and your financial goals. A bond is issued with a stated value, known as the par, or face, value. This is the value at which the bond will be bought back by the issuer upon its maturity. While a bond's current value can and usually does fluctuate during its lifetime, this par value remains fixed. At issue, most bonds also offer a fixed interest rate, or coupon rate. This is the annual rate of interest, calculated as a percentage of par, that the holder of the bond will earn.