Bond investors are faced with reinvestment--the threat that if interest rates fall, the interest payments and principal that investors receive will have to be reinvested at lower rates. This is important because the yield-to-maturity calculation assumes that all payments received are reinvested at the exact same rate as the original bond's coupon rate. However, this is rarely the case. As a result, brokers and portfolio managers try to account for reinvestment risk by calculating a bond's duration--the number of years required to recover the true cost of a bond, considering the present value of all coupon and principal payments received in the future. Duration can be used to compare bonds with different issue and maturity dates, coupon rates, and yields to maturity. The duration of a bond is expressed as a number of years from its purchase date.
Properties of Bond Duration >>