Explain the concept of bond duration.

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 calculated by taking into account the present value of each cash flow and multiplying it by the time until it is received. The present value of each cash flow is discounted at the bond's yield to maturity or required rate of return.

The concept of bond duration is important because it helps investors understand the potential impact of interest rate changes on the value of their bond investments. Generally, bonds with longer durations are more sensitive to interest rate fluctuations, while bonds with shorter durations are less sensitive.

For example, if interest rates rise, the present value of future cash flows decreases, causing the bond's price to decline. The longer the duration of the bond, the greater the price decline. Conversely, if interest rates decrease, the bond's price increases, with longer duration bonds experiencing larger price increases.

Duration also helps investors compare the interest rate risk of different bonds. It allows them to assess which bonds are more or less sensitive to interest rate changes and make informed investment decisions based on their risk tolerance and investment objectives.

Overall, bond duration provides a useful tool for investors to manage interest rate risk and make informed decisions regarding their bond investments.