Duration and Convexity [Concepts Series]

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Duration is a fundamental financial concept, but it’s more part of the fixed income investor toolkit than the equity investors’. For reasons I’ll get into, duration is usually a misleading concept for equity investors, but there are a few cases where that’s changing.

Duration in bond investing refers to two different measures, which are, conveniently, measured roughly the same way:

1. The weighted average time in the future at which a bond pays its returns — i.e. the number of years from now when you’ll realize half of the net present value of the bond, and
2. A bond price’s sensitivity to changes in interest rates, all else being equal.

It’s intuitive that these concepts would be related: the longer in the future a given stream of cash flows is, the more sensitive its value is to interest rates.

Here’s a quick table, looking at a bond with a 4% coupon paid every six months:

The important things to pay attention to are the discount rates (at the top) and the PV/Duration numbers at the bottom. The PV number is the present value of the cash…