The Securities Litigation Expert Blog

Finra Issues Investor Alert on Duration Risk

Posted by Jack Duval

Feb 15, 2013 4:26:47 AM

Finra has issued an Investor Alert explaining duration risk.  (Finra)  For those of you unfamiliar with duration, here's what you need to know from the Investor Alert:

The higher a bond’s duration, the greater its sensitivity to interest rates changes. This means fluctuations in price, whether positive or negative, will be more pronounced. If you hold a bond to maturity, you can expect to receive the par (or face) value of the bond when your principal is repaid, unless the company goes bankrupt or otherwise fails to pay. If you sell before maturity, the price you receive will be affected by the prevailing interest rates and duration. For instance, if interest rates were to rise by two percent from today’s low levels, a medium investment grade corporate bond (BBB, Baa rated or similar) with a duration of 8.4 (10-year maturity, 3.5 percent coupon) could lose 15 percent of its market value. A similar investment grade bond with a duration of 14.5 (30-year maturity, 4.5 percent coupon) might experience a loss in value of 26 percent.1 The higher level of loss for the longer-term bond happens because its duration number is higher, making it react more dramatically to interest rate changes. (Emphasis added)

There is no doubt that from current levels, a rise in interest rates has the potential to cause widespread losses, especially in lower-quality issues.  Hat tip to Finra for trying to get ahead of it with their investor education efforts.  Compliance and supervisory personal should take note as well.

See our previous coverage of interest rate risk here, here, and here.

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Topics: FINRA, duration, investments, risk, fixed income, Compliance, education

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