You now know that when interest rates rise, bond prices fall. But not all bonds fall the same amount. A 30-year government bond will crater far harder than a 2-year note when rates move by the same amount. The concept that explains this difference — and lets you quantify it precisely — is duration.
Think about cash flows. A 2-year bond returns most of its value quickly — you get coupons for two years and then the principal. If rates rise, only those two years of cash flows need to be re-priced at a higher discount rate. A 30-year bond has 30 years of cash flows sitting out in the future. All of those distant payments get discounted more heavily when rates rise — so the price falls much further.
The further in the future a cash flow sits, the more sensitive its present value is to changes in the discount rate. Long-maturity bonds have more future cash flows, so they're more sensitive.
Macaulay duration measures the weighted average time until you receive all a bond's cash flows, expressed in years. A bond with a Macaulay duration of 7 years means the average cash flow arrives in 7 years. The higher the duration, the more sensitive the bond.
More practically useful is modified duration: the approximate percentage price change for a 1% change in yield.
If yields rise by 1%: Bond A falls ~1.9%, Bond B falls ~8.5%, Bond C falls ~18%. Same rate move, very different outcomes. This is why long bonds are far riskier in a rising rate environment.
2022 was the worst year for bond returns in modern history. The US Federal Reserve raised rates from near 0% to over 4% in less than a year. Long-duration government bonds fell 30–40%. The iShares 20+ Year Treasury Bond ETF (TLT) — one of the most widely held bond ETFs — lost roughly 33% in 2022. Investors who had bought long bonds as "safe havens" were stunned. The safety was from credit risk; the interest rate risk was enormous.
Duration is a linear approximation — it assumes price changes proportionally to yield changes. In reality, the relationship curves. Convexity captures this curvature: when yields fall a lot, bond prices rise more than duration predicts; when yields rise a lot, prices fall less than duration predicts. Convexity is a bonus for bondholders — it means the actual price change is slightly better than the duration estimate in both directions.
How to use duration as an investor: when you expect rates to fall, buy long-duration bonds — they'll gain the most. When you expect rates to rise, stay short — 1–3 year bonds whose price is barely affected. Bond ETFs always quote their duration. A "short-duration bond fund" has a duration of 1–3 years and is relatively stable. A "long-duration" fund might have a duration of 15+ years and can swing 15%+ on a 1% rate move.
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