What is a Bond? A certificate of debt issued by the company, giving a fixed income on principal invested (Coupon payments) and face value on maturity is called a bond. A Bond is a loan held by individuals. These are secured in nature, i.e. the company has to sell its assets to repay such loans. What is Duration in a Bond? Bond Duration refers to the measurement of how much time t takes for the price of the bond to be matched by the income (i.e. interest earned on bonds plus the amount received on maturity) it generates. In a bond market, the duration of the bond is fixed by the interest rates. A change in the bond price for a corresponding change in interest rate is known as its duration. What is an Interest rate? Interest rate refers to the inflation rate or the rate of return in an economy. This rate is a reflection of macroeconomic variables such as government policy, socioeconomic factors, cultural influence, etc which affect the price of a bond. Interest rate risk refers to a change in the value of a bond due to a change in interest rates. Favourable factors like a stable government will reduce the interest rate and this will reduce the interest rate risk and improve the bond value concerning the duration. Interest rate risk is how bond prices react to changes in interest rates, it is measured by duration. There is an inverse relationship between the bond duration and the interest rate risk. A higher interest rate along with a longer duration bond will reduce the current market value of the bond due to the discounting factor(Bringing the future cash inflows to its current value) being a heavy variable. The investors usually hedge (potential loss secured against sure profit) fixed-income securities and interest rate swaps. That is swapping fixed interest rates with variable interest rates so that fluctuations in one type can be adjusted through the nature of the other. Thank you.
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