Understand Duration: A Key to Bond Interest Rate Risk

Duration quantifies interest rate risk for bonds, indicating how much a bond's price will change in response to interest rate shifts. A bond with a duration of five will decline by approximately 5% if rates increase by 1%. While this offers a straightforward average for a bond or portfolio, it's essential to consider different durations, such as key rate durations at various points on the yield curve (e.g., two-year, five-year). Credit spread duration is another crucial factor, relating to price changes due to shifts in credit spreads. Investors need to grasp these measures to assess their exposure and potential losses from interest rate fluctuations. The example of the Fed raising rates since March 2022 highlights the significant impact on bond performance, as evidenced by a 13% decline in the aggregate index during a notably poor year for bonds.