What is the significance of a bond's duration being expressed in years?

What is the significance of a bond's duration being expressed in years?

• A. It indicates the bond's interest rate
• B. It measures the cash flow regularity
• C. It reflects the length of time for cash flow to pay for itself
• D. It determines the bond's yield

Answer: (C)

A bond's duration, expressed in years, serves to measure the time it takes for the bond's cash flows to effectively pay back the initial investment in present value terms. This concept, known as Macaulay duration, averages the time until cash flows are received, weighted by the present value of those cash flows. A longer duration indicates that it will take more time for the bondholder to recoup their investment, and it also reflects the bond's sensitivity to changes in interest rates. Duration is critical because it helps investors understand the interest rate risk associated with the bond. For instance, when interest rates rise, the prices of bonds with longer durations typically fall more than those with shorter durations. Thus, the significance of duration extends beyond just the time until maturity; it encapsulates the bond's cash flow dynamics and its responsiveness to market conditions.

A bond's duration, expressed in years, serves to measure the time it takes for the bond's cash flows to effectively pay back the initial investment in present value terms. This concept, known as Macaulay duration, averages the time until cash flows are received, weighted by the present value of those cash flows. A longer duration indicates that it will take more time for the bondholder to recoup their investment, and it also reflects the bond's sensitivity to changes in interest rates.

Duration is critical because it helps investors understand the interest rate risk associated with the bond. For instance, when interest rates rise, the prices of bonds with longer durations typically fall more than those with shorter durations. Thus, the significance of duration extends beyond just the time until maturity; it encapsulates the bond's cash flow dynamics and its responsiveness to market conditions.