The Relation Between Time to Maturity & Bond Price Volatility | Finance - Zacks
The Relation Between Time to Maturity & Bond Price Volatility When investing in bonds, it is sometimes tempting to go for longer-term bonds with higher yields. When investing in bonds, it is sometimes tempting to go for longer-term bonds with higher yields. The price or market value of an investment bond is based on the rate of interest the bond pays -- called the coupon rate -- compared to the current market yield for similar bonds. Interest rates and bond prices have an inverse relationship; so when one goes the attractiveness of a particular bond: the length of time until the bond matures, illustration assumes a 7% coupon, $1, face value, and a year maturity.
Bond Price Function The price or market value of an investment bond is based on the rate of interest the bond pays -- called the coupon rate -- compared to the current market yield for similar bonds.
The Relationship Between Bonds and Interest Rates
If a bond's coupon rate is higher than market rates, the value of the bond will be higher than the face amount to bring the yield an investor earns in line with current rates. This is called a premium bond. A discount bond is priced below the face amount, because the bond's coupon rate is lower than current market rates.
Bond prices move inversely to interest rate changes. Factors Affecting Price Volatility Two features of bonds affect the price volatility in response to changes in market interest rates. A bond with a lower coupon rate will be more volatile than a bond with a higher coupon rate.
Also, longer-term bonds are more volatile than bonds with a shorter time to maturity.
Volatility in this case is the amount a bond's price changes in response to a specific change in interest rates. Bond Duration The mathematical concept of bond duration can be used as a measure of the volatility or risk of a bond.
Duration is similar to maturity but is a measure of the cash flow of a bond: Because bonds with shorter maturities return investors' principal more quickly than long-term bonds do. Therefore, they carry less long-term risk because the principal is returned, and can be reinvested, earlier. This hypothetical example is an approximation that ignores the impact of convexity; we assume the duration for the 6-month bonds and year bonds in this example to be 0.
Duration measures the percentage change in price with respect to a change in yield. FMRCo Of course, duration works both ways. If interest rates were to fall, the value of a bond with a longer duration would rise more than a bond with a shorter duration. Using a bond's convexity to gauge interest rate risk Keep in mind that while duration may provide a good estimate of the potential price impact of small and sudden changes in interest rates, it may be less effective for assessing the impact of large changes in rates.
This is because the relationship between bond prices and bond yields is not linear but convex—it follows the line "Yield 2" in the diagram below. This differential between the linear duration measure and the actual price change is a measure of convexity—shown in the diagram as the space between the blue line Yield 1 and the red line Yield 2.
Relationship between price and yield in a hypothetical bond The impact of convexity is also more pronounced in long-duration bonds with small coupons—something known as "positive convexity," meaning it will act to reinforce or magnify the price volatility measure indicated by duration as discussed earlier.Relationship between Bond Price & Interest Rate
Keep in mind that duration is just one consideration when assessing risks related to your fixed income portfolio. Credit risk, inflation risk, liquidity risk, and call risk are other relevant variables that should be part of your overall analysis and research when choosing your investments.
What’s the Difference Between Duration and Maturity? | BlackRock Blog
Viewing and using duration data on Fidelity. Take a test drive by signing up for Guest Access. Managing the duration of your portfolio Accessing the duration of an individual investment Plot the duration of your fixed income holdings using Fidelity's Guided Portfolio SummarySM GPS to see at a glance the weighted average duration of your fixed income holdings at Fidelity.
The duration of your fixed income investments is also plotted on a grid in comparison to the benchmark.
Duration: Understanding the relationship between bond prices and interest rates
Use the Interest Rate Sensitivity Illustrator to calculate the impact of interest rate changes on the value of your bond and bond fund holdings. View duration in the Fixed Income Analysis tool to see the duration of your bonds, CDs, and bond funds.
Also, model the hypothetical addition to your portfolio of new bonds to see how they might impact the duration of the overall portfolio. Locate a bond fund's duration in the bond fund's online profile under Portfolio Data.
The Relationship Between Bonds and Interest Rates- Wells Fargo Funds
Locate a bond ETF's duration from either the Snapshot page or Key Statistics, where the duration of the specific ETF can be compared to the asset class median duration.
Locate a bond's duration under each bond's Bond Details page. Compare the duration of two bonds.