Duration Of Bond

Many that look to long term investing consider bonds as an option. Most are thought of as safe due to the backing they receive from local, state or national governments. In the world of investing however nothing is risk free and bonds are no exception to this rule. Something that bond holders need to think about before purchasing is the bond duration.

Duration is a relatively easy concept to understand and is quite straight forward. Basically it is the amount of time that is required for a bond to pay back its initial cost. For example, many think that throwing their money into a 30 year bond is the easiest way to accumulate a fair amount of money. The money has time to mature as well as the backing it receives. What many fail to realize is that over the span of 30 interest rates can fluctuate leaving the bond vulnerable to many changes.

For example, consider two bonds both valued at 1000 dollars. Both bonds carry a yield of 5 percent. The only difference is that one bond matures in one year while the other takes 10 years. The 1 year bond has a much shorter duration and will pay back its costs quicker. It also has far less exposure to fluctuating interest rates.

Another factor in duration is looking at the coupon or interest rate. The higher the interest rate on the bond the faster it will repay the initial costs. Duration can be made to work for the investor. Those that anticipate a cut in interest rates will work to increase the duration on their bonds. With low interest rates the longer duration will eventually pay the bond holder back their initial costs. The opposite also holds true. If interests rates are expected to go up then the investors will attempt to shorten their bond duration. They will want to regain their investment before the rates change again.

Investing in bonds is generally considered safe however nothing is completely risk free. The bond holder can still loose out if they do not take advantage of duration and the rate of interest.