What is bond duration & why is it important?

Duration can measure how long it takes, in years, for an investor to be repaid a bond’s price by the bond’s total cash flows. Duration can also measure the sensitivity of a bond’s or fixed income portfolio’s price to changes in interest rates.

What is effective duration?

Effective duration is a useful measure of the duration for bonds with embedded options (e.g., callable bonds). A bond with an embedded option tends to behave differently from an option-free bond when yields move as the bond may be either called or put if the embedded option is in-the-money.

How do you calculate the duration of a bond?

By taking our modified duration measure and multiplying that by the dollar price of our bond and then by a factor of 0.01, we arrive at a duration measure which gives an actual price change for a bond given a 100 basis point (or 1%) change in yield, which is clearly denoted in dollar terms.