Duration
Quantitative Finance glossary · Quantitative Finance
Definition
Proportional sensitivity of bond price to yield, measured in years. Macaulay duration is the cash-flow-weighted average time-to-receipt D_Mac = sum_i t_i · (PV(CF_i))/(P); modified duration D_mod = D_Mac/(1 + y/k) gives the first-order price approximation Δ P / P ≈ -D_mod,Δ y. DV01 (dollar value of one basis point) = P · D_mod · 10^-4 is the trading-desk currency. Effective duration uses bumped pricing — the correct measure for callable/MBS bonds whose cash flows are rate-dependent.
Duration in plain English
Duration measures how sensitive a bond's price is to changes in interest rates, conveniently expressed in years. The intuition: a bond is a series of future payments, and duration is essentially the weighted-average time until you get your money back — pay-you-back-sooner bonds are less rattled by rate moves than pay-you-back-later ones. A slight tweak, 'modified duration', turns this into a direct price rule: Δ P / P ≈ -D_mod,Δ y, meaning a longer duration bond loses more value when rates rise. Traders often talk in DV01, the dollar change for a one-basis-point (one hundredth of a percent) rate move; and for bonds whose payments themselves shift with rates (like mortgages), they use 'effective duration', which re-prices the bond under nudged-up and nudged-down rates rather than assuming fixed cash flows.
Learn these first
Related Quantitative Finance terms
Quantitative Finance practice questions · Quantitative Finance flashcards · Quantitative Finance study guide