You will be able to use duration to estimate the price change of a bond or bond fund for a given change in yields.
Hui Min's friend Ravi tells her his bond fund fell about 7% in a year when rates rose by roughly one percentage point. Hui Min's own two-year bond barely moved over the same stretch. Same rate rise, very different damage. The difference has a name, and once you know it you can estimate how much any bond or bond fund is likely to fall before it happens.
Duration is a measure of how sensitive a bond's price is to a change in yields. The practical version, the one fund factsheets usually quote, works like this: duration is roughly the percentage change in price for a one percentage point change in yield, in the opposite direction.
So a bond with a duration of 2 should fall about 2% if yields rise by one point, and rise about 2% if they fall by one point. A bond with a duration of 7 should move about 7%.
Strictly, there are a few versions of duration, and the one used for this estimate is often called modified duration. For a reader of factsheets the distinction rarely matters. When a fund page says "duration 6.5 years", you can read it as about 6.5% of price per point of yield.
Two things push duration up.
The first is time to maturity. A bond that repays in two years gets most of its value back soon, so a change in the discount rate has only two years to act on it. A bond that repays in ten years has its biggest payment far in the future, and as lesson 2.1, Price and yield move in opposite directions, showed, discounting over many years magnifies any change in the rate. Using made-up bonds with a 3% coupon, priced at 100 with yields at 3%, a two-year bond has a duration of about 1.9 and a ten-year bond about 8.5.
The second is a lower coupon. A bond with small coupons keeps more of its value tied up in the final repayment, which is the payment furthest away. With the same made-up ten-year term and yields at 3%, a bond paying a 1% coupon has a duration of about 9.2, while one paying a 5% coupon has about 8.0.
Put those together and you get a rule of thumb: long, low-coupon bonds swing the most. Short bonds with healthy coupons swing the least. T-bills, which mature within a year, barely register.
Take a made-up eight-year bond with a 3% annual coupon, priced at 100 when yields are 3%. Its duration works out at about 7.0.
The rule says a one point rise in yields, to 4%, should cut the price by about 7%, to roughly 93. Pricing it properly with the method from lesson 2.1 gives 93.27, a fall of 6.73%. The estimate is close.
Now try two points. Duration predicts a fall of about 14%. The full calculation at 5% gives a price of 87.07, a fall of 12.93%. The estimate is a little too gloomy for big moves, because the price curve bends: each extra point of yield knocks off slightly less than the one before. For everyday planning that is a useful margin of safety rather than a problem.
In money terms, S$10,000 in a bond or fund with a duration of 7 would fall by about S$700 if yields rose one point. That is what happened to Ravi. His fund's duration was around 7, and his statement showed it.
Here is the part that matters for your own decisions. A price fall only becomes a real loss if you sell at that price. If you hold a single bond to maturity and the issuer pays, you get face value back whatever happened to rates in between.
So interest rate risk bites hardest when two things coincide: a rise in yields, and a date on which you need the money. Hui Min plans to use S$40,000 for a home down payment in two years. If that money sat in a fund with a duration of 7 and yields jumped one point the year before she needed it, she could be about S$2,800 short on the day. In her two-year bond, with a duration under 2, the same rise would cost far less on paper, and nothing at all if she simply waited the few months to maturity.
The practical rule follows. Keep the duration of what you hold shorter than the time until you need the money, and for a fixed date, consider instruments that mature on or before that date. Lesson 7.1, A bond fund never matures, and that changes everything, comes back to why a fund behaves differently from a single bond here.
You rarely need to calculate duration yourself. Bond fund and bond ETF factsheets usually state it, sometimes as "effective duration" or "modified duration", near the yield and average credit rating. For a single bond, many broker and bank pages show it alongside the price. Pick a factsheet for one bond fund or ETF, find its stated duration, and use the rule from this lesson to estimate what would happen to its price if yields moved.
Find the stated duration on one bond fund or bond ETF factsheet and estimate its price change if yields rose by one and by two percentage points.
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