Explain the concept of bond duration and its importance for bondholders.

Bond duration is a measure of the sensitivity of a bond's price to changes in interest rates. It represents the weighted average time it takes for an investor to receive the bond's cash flows, including both coupon payments and the return of principal. Duration is expressed in years and provides an estimate of the bond's price volatility.

The importance of bond duration for bondholders lies in its ability to help them assess the potential impact of interest rate changes on their bond investments. Duration allows bondholders to understand how sensitive their bond's price is to fluctuations in interest rates. This is crucial because when interest rates change, bond prices move in the opposite direction.

For example, if a bond has a duration of 5 years and interest rates increase by 1%, the bond's price is expected to decrease by approximately 5%. Conversely, if interest rates decrease by 1%, the bond's price is expected to increase by approximately 5%. Bondholders can use duration as a tool to estimate the potential price change of their bonds in response to interest rate movements.

Furthermore, duration helps bondholders compare different bonds and make informed investment decisions. Bonds with longer durations are generally more sensitive to interest rate changes, meaning their prices will fluctuate more in response to interest rate movements. On the other hand, bonds with shorter durations are less sensitive to interest rate changes and offer more stability in price.

Bond duration also plays a role in managing bond portfolios. By understanding the duration of individual bonds, investors can construct a portfolio with a desired overall duration. This allows them to align their portfolio's sensitivity to interest rate changes with their investment objectives and risk tolerance.

In summary, bond duration is a crucial concept for bondholders as it helps them assess the potential impact of interest rate changes on their bond investments. It allows bondholders to estimate the price volatility of their bonds, compare different bonds, and manage their bond portfolios effectively.