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[By Dr. David Edward Marcinko; MBA, CMP™]

Because of today’s stock market volatility, and virtual collapse in some banks and world equities, an interesting question often arises when the physician-investor considers investing in bonds; as more and more are doing.

Question

How much will a bond’s price change from a 1 percent change in interest rates? 

Duration Defined

To answer this, consider the concept of duration.  According to Jeff Coons PhD, CFP™, a bond’s duration is the weighted average life of its cash flows.

Thus, if your bond pays $60 per year in coupon payments for ten years and $1,000 in par value at the end of the ten years, the duration is the length of time that it takes for you to receive the present value of the coupon payments and par value. 

CITE: https://www.r2library.com/Resource/Title/082610254

Rule-of-Thumb

How does this help answer the original question?  There is a handy rule-of-thumb that says the duration of a bond times the change in market interest rates is the approximate price change of the bond.  Thus, the price of a ten-year Treasury bond with a duration of approximately 7.8 years will appreciate (decline) by about 7.8 percent with a drop (increase) in interest rates of 1 percent.

Assessment

For each of the two basic types of bonds, the duration is the following:

1. Zero-Coupon Bond – Duration is equal to its time to maturity, and

2. Vanilla Bond – Duration will always be less than its time to maturity. 

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Filed under: Glossary Terms, Health Economics, Healthcare Finance, Investing, Portfolio Management | Tagged: bond duration |