The duration of fixed-income securities gives investors an idea of the sensitivity to potential interest rate changes.
Duration is a good measure of interest rate sensitivity because the calculation includes multiple bond characteristics, such as coupon payments and maturity.
Are short term bonds more sensitive to interest rate changes?
There is a greater probability that interest rates will rise (and thus negatively affect a bond’s market price) within a longer time period than within a shorter period. With short-term bonds, this risk is not as significant because interest rates are less likely to substantially change in the short term.
What happens to bonds when interest rates rise?
When bond prices rise, yields fall, and vice versa. Hence, when fear rises and money flows into bonds, it pushes prices higher and yields lower. Therefore, when interest rates rise, bond prices fall, and bond investors, especially those who remain in bond funds, will feel some degree of pain.
What is Bond sensitivity?
Fixed-income investments are very sensitive to interest rate changes. A bond’s duration reflects changes in the bond’s price for each 1% fluctuation of the interest rate. A bond with a long maturity and low coupon has a longer duration and therefore is more sensitive to rate fluctuations.
Do securities that are more interest rate sensitive have higher liquidity risk?
When market interest rates rise, holders of the one-year security could reinvest in a higher-rate security after having a lower return for only one year. The longer a security’s maturity, the more its price declines to a given increase in interest rates.