1. The

change in the

value of a

fixed income security that will

result from a 1% change in

interest rates. Duration is stated in years. For example, a 5 year duration

means the bond will

decrease in value by 5% if

interest rates

rise 1% and

increase in value by 5% if interest rates

fall 1%. Duration is a

weighted measure of the length of time the bond will

pay out. Unlike

maturity, duration

takes into

account interest

payments that occur throughout the course of

holding the bond. Basically, duration is a

weighted average of the maturity of all the

income streams from a bond or

portfolio of bonds.

So, for a two-year bond with 4 coupon payments every six months of $50 and a $1000

face value, duration (in years) is 0.5(50/1200) + 1(50/1200)+ 1.5(50/1200)+ 2(50/1200) + 2(1000/1200) = 1.875 years.

Notice that the duration on any bond that

pays coupons will be

less than the maturity because there is some

amount of the payments that are going to come before the

maturity date. In this example, the maturity was 2 years.

Investors use duration to measure the

volatility of the bond. Generally, the higher the duration (the longer an investor needs to wait for the bulk of the payments), the more its

price will

drop as interest rates go up. Of course, with the added

risk comes greater

expected returns. If an investor

expects interest rates to fall during the course of the time the bond is

held, a bond with a long duration would be appealing because the

bond's price would increase more than

comparable bonds with shorter durations.

2. More generally, an interval of time.