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What is Duration?

Duration is a measure of a bond's interest-rate sensitivity. Like a bond's maturity, a bond's duration is expressed in years. But unlike maturity, which is the length of time until a bond's interest payments cease and its principal is paid back, duration also incorporates a bond’s yield, coupon, maturity, and call features.

You could think of duration as the number of years required to recover the true cost of a bond. The duration of an interest-paying bond will always be shorter than its maturity because the payments allow you to recoup some of the cost of the bond before its maturity. The higher the bond’s yield, the shorter the duration--this makes sense because the individual payouts are higher and the investor is recouping the original cost of the bond faster.

Duration can help investors anticipate and understand price fluctuations that are due to interest-rate movements. (Bond prices have an inverse relationship with interest rates.) In simple terms, a bond's duration will estimate how its price will be affected by interest-rate changes. The longer a fund's duration, the more sensitive the fund is to shifts in interest rates. In other words, if rates move up by 1 percentage point, the price of a bond with a duration of 5 years will move down by around 5%, while a bond with a duration of 10 years will move down by about 10%.

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