We cover how to calculate the duration or Macaulay duration of a bond which is a measure of bond price sensitivity. The duration is the weighted average maturity of a bond as shown in the formula below. In our example, we’ll assume that we have a bond with a par value of £100, a coupon rate of 7%, 5 years to maturity and a yield to maturity of 5%. We then compare the duration of a 7% coupon bond with a 6% coupon bond. If we decrease the coupon rate, the duration increases. This means that an investor who switches from the 7% to the 6% bond will have a greater interest rate risk. The same applies when we increase the maturity. This increases the duration which increases the interest rate risk.
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