ABSTRACT
The risk inherent in the price fluctuations of bonds has many dimensions. These include default risk, inflation risk, and call risk. The most important single source of risk, particularly for government and high-grade corporate bonds, is basis-risk price fluctuations caused by shifts in interest rates. Duration may be interpreted as an attempt to quantify this qualitative statement through the use of a single, numerical measure intended to be used in place of maturity. Before examining the theory and use of duration, we review some of the recent literature on the subject. The chapter shows that, under certain restrictive assumptions about how shifts in the yield curve occur, Macaulay's duration could be used to construct an "immunized" bond portfolio; that is, a portfolio with a return guaranteed to be at least as large as that implied by the forward rates of interest.
