Joseph Davis’ article explains various scenarios for interest rates. For those of you unfamiliar with some of the common terminology used to explain bonds, here is a brief primer.
Duration: A measure of how sensitive a bond is to changes in interest rates. (Bond prices are inversely related to yields. As yields rise, bond prices fall. As yields fall, bond prices rise.) Duration is calculated from the present value of all future cash flows, which include coupon payments (scheduled interest payments based on the terms stipulated in the bond) and the price at which the bond will be sold or redeemed. Duration is displayed as number of years, with lower-yielding bonds having a duration closer to the number of years until maturity than higher-yielding bonds. A higher level of duration implies a greater volatility in a bond’s price. Duration, however, is typically less than a bond’s maturity because of the flow of coupon payments. (The one exception is zero-coupon bonds, where duration equals maturity.)
Forward Rate: An estimate of bond yields at some point in the future, it is the market forecast level of what interest rates will be. The forward rate can be derived from the yield curve, using bonds of different maturities (e.g., a six-month and a one-year bond).
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