When thinking about interest rate risk, it is important to be aware that bond prices and yields or interest rates are inversely related to each other what this means is that if interest rates increase investors require a higher rate of return and as a result, the higher required return is applied to the Future cash flows on the bond to give you a lower present value of those cash flows and therefore in other words the bonds price. However, not all bonds react to the same degree when interest rates change so understanding the degree of interest rates sensitivity that a bond has to a change in interest rates is really important to understanding how much interest rate risk. There is within a particular Bond portfolio. Interest rates sensitivity describes the magnitude or the degree to which the bonds price changes as a result of a change in interest rates. So with the inverse relationship between yields and bond prices, we then need to have some understanding as to the level of likely change in a Bond's price as interest rates change. There are some high-level Concepts that we can have to identify which types of bonds are likely to have more or less interest rate risk first amongst these is that bonds with longer times to maturity or longer terms are going to be more sensitive to changes in interest rates or yields what that means is if you have two bonds which are identical except for their time to maturity and interest rates change then the bonds with the longer time some majority are going to see a greater reaction in their price. Bonds with a lower time to maturity will have a lower reaction or percentage change in their price for a given change in interest rates.

We can say a similar thing about the coupon rate on the bond. If we compare two bonds that are the same except for their coupon rate. Then the bond with the lower coupon rate is going to be more sensitive to a change in interest rates. So bonds with low coupons where more of the cash flow is stored in the Redemption Cashflow payment are going to be more sensitive to change the interest rate. There will be a bigger movement in percentage terms in those bonds with lower coupons. Assuming that everything else is the same. However, in the real world, we generally aren't going to be comparing bonds that are the same just for one factor will typically be comparing bonds that are different by many different factors, maybe having different maturity rates and differing coupon rates. So if we're looking at Bond 1 and bond two here where Bond 1 has a longer time to maturity six years rather than the five years on bond 2. But one two has a lower coupon rate of only one percent compared to the 15% on bond one. Well, we can't use those higher level Concepts to make our comparison. We cannot say just by looking at these characteristics of the bonds where the bond one or one two will have more sensitivity to a change in interest rates as a result. We need some Metric that's going to enable us to be able to make comparisons between bonds of differing characteristics and that metric is duration.