How Bonds React to Interest-Rate Changeshttp://www.fool.com/investing/dividends-income/2010/06/22/how-bonds-react-to-interest-rate-changes.aspx Chuck Saletta
June 22, 2010
If you buy a standard plain-vanilla fixed-rate bond, you can expect to receive its coupon interest payment on a regular basis, until that bond matures or the company declares bankruptcy. Assuming that the company stays out of bankruptcy court, you'll get the last coupon payment -- and regain the bond's face value -- on its maturity date.
That's the great part about bonds: As long as the company behind a bond remains solvent, you can predict what you're going to get by owning it. And because those cash flows are so predictable, you can get a pretty good feel for how those bonds will react to changes in interest rates.
How price and yield are related
While the math behind the formula is somewhat complicated, there are websites that can do the calculations for you, as can spreadsheets like Microsoft Excel. At its core, though, there are only a handful of factors that play into that value. The most critical ones are:
The higher the yield to maturity and the coupon yield, the lower the modified duration; and the shorter the time until maturity, the lower the modified duration.
Put it all together, and you get modified durations like these: