This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Bond Duration and Convexity: Practical Application

Now imagine that each bucket is filled to a level representing the present value of that payment. The further out the plank you go, the smaller the present value of that payment. This represents the time value of money: $30 tomorrow is worth more than $30 five years from now, assuming normal economic conditions.

The plank is essentially a timeline, and duration is the point along the plank where a fulcrum would go to balance the whole system. (The buckets themselves, for argument's sake, don't weigh anything.) Can you see why the duration of a zero-coupon bond would be equal to its maturity? Because the payment stream from a zero-coupon bond consists entirely of a single payment at maturity, that's where the fulcrum would have to go.

So, what's the use of knowing a bond's duration? If you know a bond's duration, you can estimate how much its price will change if its yield changes. Note that there are different types of duration. The one described above is Macaulay duration, defined by Frederick Macaulay in his 1938 study of U.S. financial markets. To easily estimate how much a bond's price will change if its yield changes, you need its modified duration, which you get by dividing the Macaulay duration by one plus half the yield. Once you know the modified duration, you can multiply it by a change in yield to calculate the approximate change in price. For example, a bond with a duration of 6.4 will go up about 6.4% in price if its yield drops by 1% (100 basis points), and down about 6.4% if its yield rises by 100 basis points.

Just a couple more points about duration.

Why it's useful: Duration gives investors a way to compare bonds with different maturities and coupons. A recent Fund Forum talked about the fact that bonds with big coupons are less interest-rate sensitive than bonds with small coupons, all things being equal. Using the Salomon analogy, you can see why. The more that's in those small buckets, relative to the amount in the big bucket, the further to the left the fulcrum will go to balance the system. In other words, the shorter the duration.

2 of 3

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 18,030.21 +6.04 0.03%
S&P 500 2,081.88 -0.29 -0.01%
NASDAQ 4,773.4720 +8.0480 0.17%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs