Newsletter Subscribe
Enter your email address below and subscribe to our newsletter
What is Key Rate Duration?
Key Rate Duration is a fixed-income risk metric that measures how sensitive a bond’s price is to changes in interest rates at specific maturity points (key rates) along the yield curve. It helps investors understand how a bond or portfolio will react to shifts in different parts of the yield curve.
Definition
Key Rate Duration is the change in a bond’s value resulting from a 1% change in interest rates at a specific maturity point while holding other key rates constant.
Key Takeaways
- Measures interest rate sensitivity at individual points on the yield curve.
- More precise than Macaulay or modified duration.
- Essential for managing yield curve risk in bond portfolios.
Understanding Key Rate Duration
Traditional duration models assume parallel shifts in the yield curve. However, real-world interest rate changes are often non-parallel—short-term rates might rise while long-term rates fall, or vice versa.
Key Rate Duration solves this problem by isolating sensitivity at different maturity points (e.g., 2-year, 5-year, 10-year rates).
Portfolio managers use it to:
- Manage exposure to interest rate movements.
- Construct hedging strategies.
- Optimise portfolio risk relative to benchmark indices.
Formula (If Applicable)
There is no single formula, but the calculation involves:
Key Rate Duration = (Bond Price After Rate Change – Bond Price Before Rate Change) ÷ (Bond Price × Rate Change)
Rate changes are applied individually to each key point on the yield curve.
Real-World Example
A pension fund might hold long-dated bonds sensitive to movements in 30-year rates. By analysing Key Rate Duration, managers can hedge long-term interest rate risk without affecting shorter maturities.
Similarly, an investment manager may overweight or underweight certain maturity points based on interest rate forecasts.
Importance in Business or Economics
Key Rate Duration is vital for:
- Risk management
- Yield curve positioning
- Regulatory stress testing
- Liability-driven investing (LDI)
It helps institutional investors maintain stability in changing market environments.
Types or Variations
- Partial Duration
- Effective Duration
- Spread Duration
- DV01 (Dollar Value of a 1 Basis Point Move)
Related Terms
- Yield Curve
- Duration
- Convexity
- Interest Rate Risk
Sources and Further Reading
Quick Reference
- Core Idea: Sensitivity to interest rate changes at specific maturity points.
- Primary Use: Managing non-parallel yield curve shifts.
- Impact: Greater precision in fixed-income risk management.
Frequently Asked Questions (FAQs)
Why use Key Rate Duration instead of regular duration?
Because interest rate movements are often uneven across the yield curve.
Who uses Key Rate Duration?
Bond portfolio managers, risk analysts, insurers, and pension funds.
Does Key Rate Duration apply to all bonds?
Yes, although its usefulness increases for portfolios with varied maturities.
