THE PROPERTIES OF DURATION

By definition, duration measures the number of years required to recover the true cost of a bond, considering the present value of all coupon and principal payments received in the future. Thus, the higher the coupon rate of a particular bond, the shorter its duration will be. In other words, the more money coming in now (because of a higher rate), the faster the cost of the bond will be recovered. The same is true of higher yields. Again, the more a bond yields in today's dollars, the faster the bondholder will recover its cost.

Conversely, longer bond maturities mean longer durations, since the fixed interest payments will be spread over longer periods and will be more greatly affected by inflation. This is best illustrated by imagining a fixed amount of money, for example $1,000, being mailed to you in small payments over time. If these payments are spread over a one-year period, you will "recover" your money faster than if the same dollar amount were spread over a five-year period.