Definition
Macaulay duration is the weighted average time to receive a bond's cash flows, measured in years. Modified duration converts this into price sensitivity: it estimates the percentage price change for a 1% change in yield. Longer duration means greater interest rate risk. Duration is the single most important risk metric in fixed income.
functions Formula
Modified Duration = Macaulay Duration / (1 + YTM/n)
lightbulb Example
A bond has Macaulay duration of 7.2 years and YTM of 5%. Modified duration = 7.2/1.05 = 6.86. A 1% rate increase causes approximately 6.86% price decline.
verified_user Key Points
- Primary measure of interest rate sensitivity
- Longer duration = greater price volatility
- Zero-coupon bonds have duration equal to maturity
- Higher coupon reduces duration