The content on this website is intended for investment professionals and institutional asset owners. Individual retail investors should consult with their financial advisers before using any of the content contained on this website. Breckinridge uses cookies to improve user experience. By using our website, you consent to our cookies in accordance with our cookie policy. By clicking “I Agree” and accessing this website, you represent and warrant that you are agreeing to the above statements. In addition, you have read, understood and agree to the terms and conditions of this website. The content on this website is not intended for use or distribution outside of the U.S., unless permitted by applicable law.


Perspective published on August 9, 2021

Duration 101

Interest rate risk, the impact on bond prices from fluctuations in interest rates, is one of the primary risks associated with bonds. It accompanies such other risks as credit, event and liquidity risks, and can have a meaningful impact on the total return of a fixed income security.

Interest rate risk is particularly top of mind now, with the Fed on its path to rate normalization and with inflation expectations rising.1 While increasing interest rates have both good and bad elements for fixed income market participants, measuring the impact of rate changes on bond prices remains an important part of investment analysis for bondholders. In this piece, we clarify duration and its role in bond investing.

Why Duration Matters

A bond is essentially a loan between two counterparties. The traditional bond structure includes a series of cash flows, such as coupon payments that occur before the bond matures, culminating with a maturity where the principal is fully repaid.

The time to maturity is certainly useful in assessing interest rate risk, as the farther into the future a bond matures, the more likely its value could be impacted by changing interest rates. However, maturity should not be viewed in isolation because it does not take into account either the timing of intermittent cash flows before the maturity date, or the potential changes to the ultimate principal repayment date. Timing must be incorporated into interest rate risk due to the time value of money: payments made over a bond’s life can be reinvested, and reinvestment risk (the risk that the payments are reinvested at a less attractive rate) increases with time.

A bond’s duration, which is used to measure a bond’s sensitivity to interest rates, considers the timing of cash flows, providing a much better starting point to assess interest rate risk, relative to maturity. That said, while duration is an important concept for bond investors, we note that it is not a “one-and-done” solution for precisely capturing interest rate risk.

Types of Duration

Macaulay Duration

In 1938, Canadian economist Frederick R. Macaulay, in his book “The Movement of Interest Rates, Bond Yields and Stock Prices in the United States Since 1856,” introduced one of the first attempts to codify interest rate risk. Macaulay Duration, as it became known, is the average number of years it will take to receive payments on a bond; importantly, this average is weighted by the capital recovered in each payment. As such, the purpose of Macaulay Duration is to calculate the average time horizon for an investment, rather than to measure price volatility resulting from interest rate fluctuations.

Modified Duration

Modified Duration adjusted the formula2 for Macaulay Duration to create a new, important calculation. It estimates the percent change in a bond’s price for a 1 percent change in the bond’s yield to maturity, which is the interest rate available in the market.3 For example, a modified duration of 2.5 indicates that for every 1 percent increase in yield to maturity, the bond’s market value will decrease by 2.5 percent (Figure 1).

Effective Duration

The drawback of Modified Duration is that it does not consider that interest rate movements can change a bond’s cash flows. For example, the cash flows of bonds with optionality4 can change with the rise or fall of interest rates.

One example of bonds with optionality is callable bonds. The issuer of a callable bond can “call” the bond prior to maturity, thereby returning principal to the bondholder earlier than expected. This typically occurs when interest rates are falling and issuers are able to call bonds with higher coupons and reissue debt at the new, lower prevailing market interest rates.

To capture the sensitivity of bonds to changes in interest rates, while also factoring in a bond’s call structure, market participants thus developed Effective Duration, or option-adjusted duration. The difference between the Modified and Effective Duration for option-free (i.e., non-callable) bonds is very small. However, for some bonds with optionality, the difference can be substantial.

Effective Duration has become an essential tool for assessing the interest rate risks of bonds with optionality, such as callable municipal bonds and mortgage-backed securities (MBS), where the timing of principal repayment is highly dependent on the level of interest rates.

While Effective Duration is a more complete measure of a bond’s sensitivity to interest rate movements versus the Macauley or Modified Duration measures, it still falls short because it is a linear approximation for small changes in yield; that is, it assumes that duration stays the same along the yield curve. This isn’t typically the case. For most bonds, as yields change, bond prices will become more, or less sensitive to yield changes. Therefore, Effective Duration becomes a less accurate estimation of price sensitivity to interest rates for larger changes in rates.

Duration as a Tool

When evaluating fixed income investments, understanding the type of duration used in portfolio reporting and the associated risks of duration is critical. As investors weigh options to manage rate volatility, we look forward to open dialogue with our clients about duration strategies and the relevance of duration to clients’ goals and risk tolerance.


[1] Interest rate risk is typically top of mind for bond investors and even more so as interest rates reset to lower levels.

[2] The modified duration is Macaulay Duration divided by one plus the yield to maturity.

[3] A bond’s yield to maturity is the discount rate that equates a bond’s price with the present value of the bond’s future payments.

[4] Optionality: bond features that can change the timing of principal repayment.

This piece was originally published on July 16, 2018

#265193 (8/6/21)


This material provides general and/or educational information and should not be construed as a solicitation or offer of Breckinridge services or products or as legal, tax or investment advice. The content is current as of the time of writing or as designated within the material. All information, including the opinions and views of Breckinridge, is subject to change without notice.

Any estimates, targets, and projections are based on Breckinridge research, analysis, and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

Past performance is not a guarantee of future results. Breckinridge makes no assurances, warranties or representations that any strategies described herein will meet their investment objectives or incur any profits. Any index results shown are for illustrative purposes and do not represent the performance of any specific investment. Indices are unmanaged and investors cannot directly invest in them. They do not reflect any management, custody, transaction or other expenses, and generally assume reinvestment of dividends, income and capital gains. Performance of indices may be more or less volatile than any investment strategy.

Performance results for Breckinridge’s investment strategies include the reinvestment of interest and any other earnings, but do not reflect any brokerage or trading costs a client would have paid. Results may not reflect the impact that any material market or economic factors would have had on the accounts during the time period. Due to differences in client restrictions, objectives, cash flows, and other such factors, individual client account performance may differ substantially from the performance presented.

All investments involve risk, including loss of principal. Diversification cannot assure a profit or protect against loss. Fixed income investments have varying degrees of credit risk, interest rate risk, default risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Income from municipal bonds can be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the IRS or state tax authorities, or noncompliant conduct of a bond issuer.

Breckinridge believes that the assessment of ESG risks, including those associated with climate change, can improve overall risk analysis. When integrating ESG analysis with traditional financial analysis, Breckinridge’s investment team will consider ESG factors but may conclude that other attributes outweigh the ESG considerations when making investment decisions.

There is no guarantee that integrating ESG analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader market or other strategies that do not utilize ESG analysis when selecting investments. The consideration of ESG factors may limit investment opportunities available to a portfolio. In addition, ESG data often lacks standardization, consistency and transparency and for certain companies such data may not be available, complete or accurate.

Breckinridge’s ESG analysis is based on third party data and Breckinridge analysts’ internal analysis. Analysts will review a variety of sources such as corporate sustainability reports, data subscriptions, and research reports to obtain available metrics for internally developed ESG frameworks. Qualitative ESG information is obtained from corporate sustainability reports, engagement discussion with corporate management teams, among others. A high sustainability rating does not mean it will be included in a portfolio, nor does it mean that a bond will provide profits or avoid losses.

Net Zero alignment and classifications are defined by Breckinridge and are subjective in nature. Although our classification methodology is informed by the Net Zero Investment Framework Implementation Guide as outlined by the Institutional Investors Group on Climate Change, it may not align with the methodology or definition used by other companies or advisors. Breckinridge is a member of the Partnership for Carbon Accounting Financials and uses the financed emissions methodology to track, monitor and allocate emissions. These differences should be considered when comparing Net Zero application and strategies.

Targets and goals for Net Zero can change over time and could differ from individual client portfolios. Breckinridge will continue to invest in companies with exposure to fossil fuels; however, we may adjust our exposure to these types of investments based on net zero alignment and classifications over time.

Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.

The effectiveness of any tax management strategy is largely dependent on each client’s entire tax and investment profile, including investments made outside of Breckinridge’s advisory services. As such, there is a risk that the strategy used to reduce the tax liability of the client is not the most effective for every client. Breckinridge is not a tax advisor and does not provide personal tax advice. Investors should consult with their tax professionals regarding tax strategies and associated consequences.

Federal and local tax laws can change at any time. These changes can impact tax consequences for investors, who should consult with a tax professional before making any decisions.

The content may contain information taken from unaffiliated third-party sources. Breckinridge believes the data provided by unaffiliated third parties to be reliable but investors should conduct their own independent verification prior to use. Some economic and market conditions contained herein have been obtained from published sources and/or prepared by third parties, and in certain cases have not been updated through the date hereof. All information contained herein is subject to revision. Any third-party websites included in the content has been provided for reference only.  Please see the Terms & Conditions page for third party licensing disclaimers.