What is 'Interest Rate Sensitivity'
Interest rate sensitivity is a measure of how much the price of a fixedincome asset will fluctuate as a result of changes in the interest rate environment. Securities that are more sensitive have greater price fluctuations than those with less sensitivity. This type of sensitivity must be taken into account when selecting a bond or other fixedincome instrument the investor may sell in the secondary market.
BREAKING DOWN 'Interest Rate Sensitivity'
Generally, the longer the maturity of the asset, the more sensitive the asset to changes in interest rates. Changes in interest rates are watched closely by bond and fixedincome traders, as the resulting price fluctuations affect the overall yield of the securities. Investors who understand the concept of duration can immunize their fixedincome portfolios to changes in shortterm interest rates.Inverse Correlation between Fixed Income and Rates
Fixedincome securities and interest rates are inversely correlated. Therefore, as interest rates rise, prices of fixedincome securities tend to fall. One way to determine how interest rates affect a fixedincome security's portfolio is to determine the duration. The higher a bond or bond fund's duration, the more sensitive the bond or bond fund to changes in interest rates. The duration of fixedincome securities gives investors an idea of the sensitivity to potential interest rate changes. Duration is a good measure of interest rate sensitivity because the calculation includes multiple bond characteristics, such as coupon payments and maturity.
Types of Duration Measurements
There are four widely used duration measurements to determine a fixedincome security's interest rate sensitivity: the Macaulay duration, modified duration, effective duration and key rate duration. To calculate the Macaulay duration, the time to maturity, number of cash flows, required yield, cash flow payment, par value and bond price must be known. The modified duration is a modified calculation of the Macaulay duration. It determines how much the duration would change for each percentage point change in the yield. The effective duration is used to calculate the duration of bonds with embedded options. It determines the approximate price decline for a bond if interest rates rise instantaneously by 1%. The key rate duration determines a fixedincome security's or fixedincome portfolio's duration at a specific maturity on the yield curve.
One widely used measure to determine the interest rate sensitivity is the effective duration. For example, assume a bond fund holds 100 bonds with an average duration of nine years and an average effective duration of 11 years. Therefore, if interest rates rise instantaneously by 1%, the bond fund is expected to lose 11% based on its effective duration.

Dollar Duration
The dollar duration, or DV01 of a bond is a way to analyze the ... 
Key Rate Duration
Holding all other maturities constant, this measures the sensitivity ... 
Modified Duration
A formula that expresses the measurable change in the value of ... 
Duration
A measure of the sensitivity of the price (the value of principal) ... 
Empirical Duration
The calculation of a bond's duration based on historical data. ... 
Sensitivity
The magnitude of a financial instrument's reaction to changes ...

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The weighted average term to maturity of the cash flows from a bond. 
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Which is a better metric, modified duration or Macaulay duration?
Learn why the modified duration is a more useful metric than the Macaulay duration, and understand how the measures are different ... Read Answer >> 
How does duration impact bond funds?
Learn how duration for a bond fund measures the risk the bond portfolio has to a rise in interest rates, and see how managers ... Read Answer >> 
How can I use a bond's duration to predict its return?
Learn how the concept of duration is used to determine when future cash flows for a bond will equal the amount paid for the ... Read Answer >> 
What is the risk return tradeoff for bonds?
Find out more about the Macaulay duration and modified duration, how to calculate them and the difference between the Macaulay ... Read Answer >> 
What does the Macaulay duration indicate about a bond?
Learn how the Macaulay duration shows the relationship between interest rate changes and the price of bonds, and see how ... Read Answer >>