What is the significance of a bond's duration?

A bond's duration is significant because it reflects the bond's interest rate risk. Duration measures how sensitive a bond's price is to changes in interest rates. The concept represents the weighted average time until a bond's cash flows are received and is expressed in years. When interest rates rise, bond prices typically fall, and the extent of this price change can be assessed using duration. The longer the duration, the greater the interest rate risk, meaning that a bond with a longer duration will experience larger price swings compared to a bond with a shorter duration when interest rates fluctuate.

Understanding a bond's duration is crucial for investors to gauge how a bond will respond to changes in market interest rates and make informed decisions regarding their bond investments. This makes it a key factor in managing portfolios, especially in environments where interest rates are expected to change significantly.