Key Rate Duration — The Dollar Dictionary

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Finance

Key Rate Duration

A measure of a bond portfolio's sensitivity to interest rate changes at specific points on the yield curve, rather than to a single parallel shift in all rates.

Standard duration (also called modified duration) measures how much a bond's price changes for a 1% parallel shift in all interest rates simultaneously. Key rate duration breaks this into segments — the 2-year key rate duration, the 5-year, the 10-year, the 30-year — showing how much the portfolio would change in value if only that specific maturity's rate moved while all others stayed flat.

This matters because yield curves don't move in parallel. A central bank raising short-term rates while long-term rates stay anchored (a curve flattening) creates very different impacts than all rates rising together. Portfolio managers use key rate duration to position deliberately — expressing a view that short rates will rise more than long rates, for example, by reducing short-end duration while maintaining long-end exposure.

Regular duration assumes interest rates move like an elevator — all floors go up or down together. Key rate duration recognizes that rates actually move like a snake — different parts of the yield curve can move independently. A portfolio might be very sensitive to 5-year rate changes but barely affected by 30-year rate changes. Key rate duration maps exactly where the exposure lives.

Real world: A pension fund managing liabilities that mature in 20-30 years needs to match its bond portfolio's sensitivity to long-term rate changes. Key rate duration analysis reveals that most of their interest rate risk sits at the 20-year and 30-year points on the curve. They can then hedge specifically those exposures — rather than hedging the entire curve — which is more precise and less expensive.

💡 Key rate duration pinpoints exactly where a bond portfolio's interest rate risk lives — essential for precision hedging in a world where different parts of the yield curve move independently.

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