Canadian Securities Course (CSC) Level 1 Practice Exam

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What does the duration of a bond describe?

  1. Approximate percentage change in bond yields

  2. Approximate percentage change in bond prices

  3. Approximate maturity period of a bond

  4. Approximate rating of a bond

The correct answer is: Approximate percentage change in bond prices

The duration of a bond is a measure that expresses how much the price of the bond is expected to change in response to changes in interest rates. Specifically, it indicates the approximate percentage change in the bond's price for a given change in yield. Duration accounts for the present value of the bond's cash flows, which include the scheduled interest payments and the return of principal at maturity. Therefore, it effectively reflects the sensitivity of the bond's price to interest rate fluctuations. This concept is particularly significant for fixed-income investors, as it helps them assess interest rate risk. A bond with a longer duration is generally more sensitive to interest rate changes than a bond with a shorter duration. Consequently, when market interest rates rise, a bond's price is likely to fall, and the calculation of duration allows investors to estimate how much price volatility to expect. In contrast, the other options do not accurately describe what duration measures. The approximate maturity period of a bond refers to the actual time remaining until the bond matures, while the approximate rating of a bond relates to its credit risk and perceived likelihood of default. The approximate percentage change in bond yields does not align with the concept of duration, which is focused on price sensitivity rather than yield expectations.

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