Duration measures the time it takes to hold a financial instrument until it matures, taking into account the changes in bond maturity, coupon payment and market interest rate. If the duration of a bond is long, it shows that its price is sensitive to the change of interest rate, that is, a small change of interest rate may cause a big change of bond price. Therefore, duration can help investors understand the sensitivity of their portfolio to changes in interest rates, so as to better manage risks.
Duration is a very important concept in the field of fixed income investment By adjusting the duration, investors can adjust the risk exposure of their portfolios. For example, if investors think that the market interest rate may fall in the future, they can increase the return of the portfolio by increasing the duration. On the contrary, if investors think that the market interest rate may rise in the future, they can reduce the risk of the portfolio by reducing the duration.
Importance of duration:
1. Measuring interest rate risk: Duration is a key indicator to measure the sensitivity of bonds or portfolios to interest rate changes. It helps investors quantify the impact of interest rate changes on bond prices. The longer the duration, the more sensitive the bond price is to the change of interest rate, and investors can manage their interest rate risk by adjusting the duration.
2. Guiding investment decision: Duration can provide valuable guidance for investment decision. In the case of expected interest rate decline, investors may choose to increase the duration to benefit from potential capital appreciation. On the contrary, when the expected interest rate rises, reducing the duration can reduce the interest rate risk of the portfolio.
3. Capture excess returns: By flexibly adjusting the duration, investors have the opportunity to capture the staged excess returns in the market. For example, if it is judged that the future funds will be further relaxed and the interest rate may go down, then a long extension can improve the sensitivity of the portfolio to the downward interest rate, thus capturing the potential capital gains.
4. Risk management: Duration can be used not only to measure interest rate risk, but also as a risk management tool. By monitoring and adjusting the maturity of the portfolio, investors can ensure that their risk exposure is consistent with their risk tolerance and investment objectives.