Explaining Duration

Course: Investment Planning
Lesson 10: Fixed Income Securities

Student Question:

I am trying to wrap my head around this. From the explanation the duration seems the point where half of the payback has happened. Is that a decent way of thinking about it?

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Instructor Response:

Close.  Duration is the weighted-average time it takes to receive the bond’s cash flows, where the weights are based on the present value of each payment.  Because earlier payments are discounted less heavily than later ones, they get more weight.

So while duration often ends up being near the point where roughly half of the bond’s present value has been paid back, it’s not literally the moment 50% of cash flows are received. It’s more of a “PV-weighted center of gravity” of the payments.

Does that help clarify here?  Let me know.