What does duration measure in the context of fixed income investments?

Duration is a crucial concept in fixed income investments as it specifically measures a bond's sensitivity to changes in interest rates. When interest rates fluctuate, the price of bonds reacts inversely; if interest rates rise, bond prices generally fall, and vice versa. Duration quantifies this relationship by indicating how much the price of a bond (or a bond portfolio) is expected to change in response to a 1% change in interest rates.

For instance, a bond with a duration of 5 years would typically experience a price decline of approximately 5% if interest rates were to increase by 1%. This characteristic makes duration a valuable tool for investors seeking to manage interest rate risk within their fixed income portfolios. By understanding duration, investors can make more informed decisions about the timing of investments and the overall risk profile of their bond holdings.