It is one of the first things people learn about bonds and one of the least intuitive: when interest rates go up, the bonds you already own go down in value. The relationship is mechanical and measurable, and once you see why, it shapes how you think about every debt investment — from a single bond to a debt mutual fund.
The seesaw
Imagine you own a bond paying a 7% coupon. Next month, newly issued bonds of similar quality and maturity pay 8%. Why would anyone pay full price for your 7% bond when a new one pays 8%? They would not. Your bond has to become cheaper — just cheap enough that a buyer earns about 8% on the price paid, through the coupon plus the gain as the price climbs back to face value at maturity.
The reverse also holds. If new bonds pay only 6%, your 7% coupon is attractive, and buyers will pay more than face value for it.
How big is the move?
For illustration, take a bond with ₹1,000 face value and a 7% annual coupon, priced at par. Here is what happens to its price if yields on similar bonds move by one percentage point:
| Remaining maturity | Yields rise to 8% | Yields fall to 6% |
|---|---|---|
| 2 years | about ₹982 (−1.8%) | about ₹1,018 (+1.8%) |
| 10 years | about ₹933 (−6.7%) | about ₹1,074 (+7.4%) |
The same one-point change moves the ten-year bond nearly four times as much as the two-year bond. The longer you are locked into a below-market coupon, the bigger the discount a buyer needs; the longer you enjoy an above-market coupon, the bigger the premium.
Duration: one number for sensitivity
Maturity alone is not precise, because bonds pay coupons along the way. Duration accounts for that.
- Macaulay duration is the weighted-average time, in years, until you receive the bond's cash flows. For the ten-year 7% bond above it is about 7.5 years; for the two-year bond, about 1.9 years.
- Modified duration turns that into price sensitivity: roughly, the percentage change in price for a one-percentage-point change in yield. For the ten-year bond it is about 7.0; for the two-year bond, about 1.8.
A modified duration of 7 means a one-point rise in yields would cut the price by about 7%, and a one-point fall would lift it by about 7%. The actual moves in the table (−6.7% and +7.4%) are slightly asymmetric because of convexity: prices rise a little more when yields fall than they drop when yields rise. Duration is the first approximation; convexity is the refinement.
What changes duration
- Longer maturity raises duration.
- A lower coupon raises duration, because more of the value arrives at the end. A zero-coupon bond has a Macaulay duration equal to its maturity.
- Higher yields lower duration slightly, because distant cash flows are discounted more heavily.
Rising rates are not only bad news
Rising rates reduce the price of bonds you hold, but they also raise the rate at which coupons and maturing money can be reinvested. For a long-term investor, a rate rise means a short-term fall in value followed by higher income. Over a holding period roughly equal to a portfolio's duration, the two effects tend to offset each other — one reason matching duration to your horizon is a sound principle.
Holding to maturity versus marking to market
If you hold an individual bond to maturity and the issuer pays as promised, you receive the coupons and face value regardless of interim price swings. The price falls along the way are real, but they disappear by maturity.
Debt mutual funds are different. They value holdings at market prices every day, so their NAV reflects rate movements as they happen, and most open-ended debt funds have no single maturity date. That is why a debt fund's interest-rate risk shows up in its returns, and why its modified duration — published in the factsheet — is one of the most useful numbers to check. Our insight on interest-rate cycles and debt funds goes further.
Putting it to work
- Match duration to your horizon. Money needed in a year sits uneasily in a portfolio with a duration of seven.
- Do not build a plan on rate forecasts. Turning points are hard to call, even for professionals. A duration chosen for your timeline is more robust than one chosen for a prediction.
- Keep credit risk separate in your mind. Duration measures sensitivity to interest rates, not the issuer's ability to pay — see credit ratings explained.
The Bond Yield & Cashflow tool lets you change price and yield inputs and see the effect on a bond's cash flows and yield. For the basics of coupon and yield, start with Bonds 101.