Duration Price-Sensitivity Rule
Estimate a bond's price reaction before interest rates move
- Difficulty
- Easy
- Time to result
- ~days to results
- Steps
- 5
- Confidence
- 98%
Duration provides a practical first estimate of how a bond's price may react to an interest-rate change. Start with the duration published for the bond or fund, multiply it by the expected rate movement in percentage points, and reverse the direction: rising rates imply falling prices, while falling rates imply rising prices. A five-year duration therefore suggests an approximately five-percent price move for a one-percentage-point rate change. Portfolio-level duration is only an average, so investors should also inspect key-rate duration to identify concentration at the two-, five-, ten-, twenty-, or thirty-year points. Credit-spread duration adds another dimension by estimating sensitivity to changes in the yield premium above Treasuries.
Origin
Extracted from Masters in Business during Karen Vera's explanation of bond duration and interest-rate risk.
Core principles
- 01Duration measures a bond's sensitivity to interest-rate changes.
- 02Higher duration creates larger price movements when rates change.
- 03Key-rate duration reveals exposure at specific points on the yield curve.
- 04Credit-spread duration is distinct from Treasury-rate duration.
How to run it
- 1
Locate the Duration
Find the published duration for the bond or bond fund. Treat it as the portfolio's approximate interest-rate sensitivity.
Pro tip Use the fund provider's current duration figure rather than estimating it from maturity alone.
Watch out Duration and maturity are related but are not interchangeable.
- 2
Define the Rate Scenario
Choose a plausible change in interest rates, expressed in percentage points. Consider both an adverse and a favorable scenario.
Pro tip Model several scenarios instead of relying on one rate forecast.
Watch out A 100-basis-point move equals one percentage point.
- 3
Estimate the Price Move
Multiply duration by the rate change and reverse the direction. For example, a duration of five with a one-percentage-point rate increase implies an approximate five-percent price decline.
Pro tip Use the result as a risk estimate rather than a precise return prediction.
Watch out Large rate movements and bond convexity can make the actual result differ from the estimate.
- 4
Inspect the Curve Exposure
Review key-rate duration to see where the portfolio is exposed along the yield curve. This matters when different maturities move by different amounts.
Pro tip Compare exposure at the two-, five-, ten-, twenty-, and thirty-year points.
Watch out A single average duration can conceal concentrated exposure.
- 5
Add Credit-Spread Risk
Check credit-spread duration for corporate or other non-Treasury bonds. Evaluate whether widening spreads could compound an interest-rate-driven loss.
Pro tip Separate Treasury-rate risk from issuer and credit-market risk.
Watch out Stable government rates do not guarantee stable corporate-bond prices.
In the wild
An investor owns a bond fund with a published duration of five. If interest rates rise by one percentage point, the rule estimates that the fund's price will decline by roughly five percent, before accounting for income, convexity, spread changes, and other effects.
→ The investor can compare the estimated decline with their risk tolerance before buying or holding the fund.
The Federal Reserve raised rates rapidly beginning in March 2022. The intermediate-duration aggregate bond index fell about thirteen percent, while twenty-plus-year Treasuries suffered losses exceeding twenty percent, illustrating how longer duration amplifies the effect of rising rates.
→ Investors saw materially larger losses in long-duration bonds than in intermediate-duration bonds.
Common mistakes
Confusing Duration With Maturity
Maturity tells you when principal is due, while duration estimates price sensitivity to rates. Using maturity alone can misstate the actual risk.
Treating Average Duration as Complete
A portfolio's average can hide substantial exposure at particular yield-curve points. Key-rate duration is needed to uncover that concentration.
Ignoring Credit Spreads
Corporate-bond prices can change because of both government rates and credit spreads. Measuring only interest-rate duration leaves part of the risk unexplained.
Is it for you?
Best for
It is best for investors comparing the interest-rate risk of bonds and bond funds before allocating capital.
Not ideal for
It is not ideal as an exact performance forecast when yield-curve shifts, credit spreads, or embedded options materially affect prices.
From the transcript
“So duration is simply the interest rate risk of a bond,”
“if interest rates go up by one percent, that bond will drop in value by five percent.”
“So like two year, we call those key rate durations, so you can think of how much am I exposed to two year point, the…”
From the episode
At the Money: Managing Bond Duration