Relationship between duration and maturity

What’s the Difference Between Duration and Maturity? -

relationship between duration and maturity

Two terms that often get confused are duration and maturity. Let's take a look at their meanings and try to set the record straight. In plain English. Duration can increase or decrease given an increase in the time to maturity (but it usually increases). You can look at this relationship in the upcoming. Investment professionals rely on duration because it rolls up several bond characteristics (such as maturity date, coupon payments, etc.) into a single number.

An example of this would be a movie with perhaps a duration of two hours or a roller coaster with a duration of one and a half minutes.

A year Treasury Bond, as the name implies, matures or pays back its face value 30 years from its initial date. Investors are not obligated to hold the bond for the entire period as they have the option of being sold within the secondary market. Individual investors or portfolio managers can buy or sell bond holdings to adjust the average maturity of the portfolio. Why would they want to do that? Generally speaking, the further out the maturity, the wider the potential price swings of the market value of the bond.

relationship between duration and maturity

That is a very important concept to bond investors, but it is a general concept as compared to an attempt at better detailing the relationship when we cover duration. Keep in mind bond investors recognize two types of return, the first is the interest payment income which may be paid quarterly, semi-annually or even annually.

If investing in a fixed-income mutual fund, interest payments are in the form of mutual fund dividends and may be paid monthly.

Duration: Understanding the Relationship Between Bond Prices and Interest Rates - Fidelity

Those payment cycles will play a role when duration is covered. The second type of return is from price changes of the bond itself why maturity matters. Bonds are often quoted with two yields.

This refers to the annual interest payable as a percent of the original face or par value. This quote takes into account the amount of years left until the bond matures and the impact the market and secondary trading of the original bond has had on the investors final total return. The formula for YTM takes several things into account: Original Face or Par Value F 3. Price bond was purchased P 4.

The Yield to Maturity is 7. Other than a few reasons that would cause a bond to end its existence prior to maturity, the life span of a bond tells an investor how long the bond may be exposed to risk — the primary one being the erosion of its value purchasing power when inflation is present higher bond price, and a lower return than the coupon rate as in example 2 on YTM.

An Introduction to Duration

Complexity increases in the details of various ways duration is calculated. We will quickly outline the calculations but then then circle back and focus on the broader concept and why investors look at duration in conjunction with maturity. Macaulay duration, modified duration and effective duration are three types of duration calculations.

  • Duration: Understanding the relationship between bond prices and interest rates
  • What’s the Difference Between Duration and Maturity?
  • The Difference Between "Maturity" and "Duration"

Investors will more than likely run across effective duration numbers. Because bonds with shorter maturities return investors' principal more quickly than long-term bonds do. Therefore, they carry less long-term risk because the principal is returned, and can be reinvested, earlier. This hypothetical example is an approximation that ignores the impact of convexity; we assume the duration for the 6-month bonds and year bonds in this example to be 0. Duration measures the percentage change in price with respect to a change in yield.

FMRCo Of course, duration works both ways. If interest rates were to fall, the value of a bond with a longer duration would rise more than a bond with a shorter duration.

relationship between duration and maturity

Using a bond's convexity to gauge interest rate risk Keep in mind that while duration may provide a good estimate of the potential price impact of small and sudden changes in interest rates, it may be less effective for assessing the impact of large changes in rates.

This is because the relationship between bond prices and bond yields is not linear but convex—it follows the line "Yield 2" in the diagram below.

relationship between duration and maturity

This differential between the linear duration measure and the actual price change is a measure of convexity—shown in the diagram as the space between the blue line Yield 1 and the red line Yield 2. Relationship between price and yield in a hypothetical bond The impact of convexity is also more pronounced in long-duration bonds with small coupons—something known as "positive convexity," meaning it will act to reinforce or magnify the price volatility measure indicated by duration as discussed earlier.

Keep in mind that duration is just one consideration when assessing risks related to your fixed income portfolio. Credit risk, inflation risk, liquidity risk, and call risk are other relevant variables that should be part of your overall analysis and research when choosing your investments.

Understanding credit spread duration and its impact on bond prices

Viewing and using duration data on Fidelity. Take a test drive by signing up for Guest Access. Managing the duration of your portfolio Accessing the duration of an individual investment Plot the duration of your fixed income holdings using Fidelity's Guided Portfolio SummarySM GPS to see at a glance the weighted average duration of your fixed income holdings at Fidelity. The duration of your fixed income investments is also plotted on a grid in comparison to the benchmark. Use the Interest Rate Sensitivity Illustrator to calculate the impact of interest rate changes on the value of your bond and bond fund holdings.

View duration in the Fixed Income Analysis tool to see the duration of your bonds, CDs, and bond funds. Also, model the hypothetical addition to your portfolio of new bonds to see how they might impact the duration of the overall portfolio. Locate a bond fund's duration in the bond fund's online profile under Portfolio Data. Learn Finance Fast - Duration

Locate a bond ETF's duration from either the Snapshot page or Key Statistics, where the duration of the specific ETF can be compared to the asset class median duration. Locate a bond's duration under each bond's Bond Details page. Compare the duration of two bonds.