A bond's price moves in the opposite direction to its yield, and how far it moves is measured by duration. Modified duration is defined by regulators as the approximate percentage change in a bond's price for a 100 basis point change in yield. A longer maturity raises duration and a lower coupon raises duration, so a long, low-coupon bond falls furthest on the same yield move. A government guarantee covers repayment at maturity, not the market price before it.
A bond pays a fixed amount on a fixed schedule. Once it has been issued, those payments do not change. Market interest rates change constantly. Everything interesting about holding a bond follows from that mismatch.
The seesaw
The Reserve Bank states the mechanism directly: the prices at which investors buy and sell bonds in the secondary market move in the opposite direction to the yields they expect to receive.
The reason is arithmetic rather than sentiment. A bond keeps paying at the rate set when it was issued. If market rates rise, newly issued bonds pay more, and nobody will buy the older bond at its original price. Its price falls until the return it offers a new buyer matches what the market now requires. If market rates fall, the logic runs the other way and the older bond becomes worth more than face value.
The Reserve Bank's own worked example makes the size of the effect visible. Take a hypothetical government bond with a ten-year term, a principal of $100 and interest of 2 per cent, so $2 a year. If the market requires 2 per cent, the bond is worth $100. If the required yield falls to 1 per cent, investors now need only $1 a year on each $100 invested, while this bond pays $2. They bid it up to about $109.50, at which price the fixed $2 a year delivers the 1 per cent the market now requires.
A one percentage point move in yields, and the price moved about 9.5 per cent. On a ten-year bond.
Duration, and why the name misleads
That 9.5 per cent is not a coincidence. It is close to the bond's duration, and duration is the property that decides how far any bond moves.
The confusion in the term is that duration is quoted in years while measuring something that is not time. Two definitions from the United States Office of the Comptroller of the Currency separate them cleanly. They describe properties of a bond rather than of a jurisdiction, so they apply here unchanged.
Macaulay duration is the weighted average time until cash flows are received, and is genuinely measured in years.
Modified duration is the approximate percentage change in a bond's price for a 100 basis point change in yield, assuming the bond's expected cash flow does not change when the yield changes.
The second is the one that matters to a holder, and FINRA, the United States broker-dealer regulator, states the rule of thumb without ceremony: for every one percentage point change in interest rates, a bond moves in the opposite direction by roughly its duration number. A bond or fund with a duration of ten falls about 10 per cent if rates rise one point, and gains about 10 per cent if they fall one point.
Two things raise duration
- Maturity. The longer the time to maturity, the greater the risk that the bond's value is affected by changing rates before it matures, and the higher the duration. This is the effect most people already have an intuition for.
- Coupon. The lower the coupon, the higher the duration.
The coupon effect is less intuitive and matters just as much. Where two bonds are otherwise identical, the United States Securities and Exchange Commission states that the one with the lower coupon rate will generally experience the greater decrease in value as market rates rise.
The reason is that a bond's price is the present value of all its cash flows, and the coupon determines how much of that value arrives early. A high-coupon bond returns a substantial part of its value through payments along the way, so its weighted average cash flow arrives sooner and a change in the discount rate has less to work on. A low-coupon bond has most of its value concentrated in the repayment of face value at the very end, which is the cash flow most exposed to discounting.
A long-dated, low-coupon bond therefore combines both effects, and is the most rate-sensitive ordinary bond there is.
What the straight line misses
Duration describes a straight line, and the real relationship between price and yield is a curve. Convexity is the name for the difference, defined by the Office of the Comptroller of the Currency as the rate at which duration changes with respect to changes in rates.
Its practical consequence is favourable to a bondholder, and it is visible in a worked example from the Securities and Exchange Commission. Take a ten-year bond with a $1,000 face value and a 3 per cent semi-annual coupon, priced at $1,000 when the market rate is 3 per cent. A year later, with nine years remaining: if the market rate has fallen to 2 per cent the price is about $1,082; if it has risen to 4 per cent the price is about $925.
The gain from the fall is $82. The loss from the equal and opposite rise is $75. Same size of move, different sized outcome, in the holder's favour. That asymmetry is convexity, and it appears without any formula being written.
It also shows why duration alone is an approximation. For small yield moves the straight line is close enough. For large ones it overstates the loss and understates the gain.
The part that catches retail holders
A government bond carries essentially no risk that the issuer fails to pay. That is why the government yield curve is called the risk-free curve.
It is not, however, free of the risk described above. The Securities and Exchange Commission states the point in terms that transfer directly to the Australian case: the guarantee covers timely interest payments and repayment of principal at maturity, and the government does not guarantee the market price or value of the bond if it is sold before it matures.
Two distinct promises, and only one of them is being made. Hold to maturity and the face value arrives as agreed. Sell earlier and you receive the market price on that day, which reflects where yields have gone since you bought.
Holding them in practice
An Australian retail investor can hold government bonds directly. The Australian Office of Financial Management, which issues them, describes Treasury Bonds as medium to long-term debt securities carrying an annual rate of interest fixed over the life of the security and payable semi-annually. Their exchange-traded form is listed and bought and sold at market value through a licensed broker, and ASIC's Moneysmart notes that brokerage is payable on top.
The indexed variety works differently enough to be worth separating. The Australian Office of Financial Management describes Treasury Indexed Bonds as securities whose capital value is adjusted for movements in the consumer price index, paying interest quarterly at a fixed rate on that adjusted capital value, and returning the adjusted capital value at maturity. So the coupon rate is fixed while the amount it is applied to is not.
The comparison with a term deposit runs in both directions. A bond can be sold whenever the market is open, so the money is not locked away. What you get for it is the market price, which may be below what you paid. A term deposit removes that price risk and replaces it with a break penalty. Neither is free.
Beyond government bonds, direct access narrows considerably. ASIC records that corporate bonds typically require minimum purchases around $500,000 and trade over the counter, with retail offerings rare, so most retail investors reach bonds through managed funds.
Where to look next
- Bond yields - the reference page for the category.
- Bond yield - the term in glossary form.
- How the yield curve prices a term deposit - the curve these prices sit on, and what its slope means.
- Term deposit rates - the alternative that removes price risk and adds a break penalty.
Sources
- Reserve Bank of Australia, Explainer: Bonds and the Yield Curve - the statement that secondary market prices move in the opposite direction to yields and why, the worked hypothetical of a ten-year bond at $100 with 2 per cent interest repricing to about $109.50 when the required yield falls to 1 per cent, the explanation that longer-term bonds are more exposed to the uncertainty that rates or inflation could rise and that investors therefore demand a higher yield to hold them, and the risk-free label for the government curve
- United States Securities and Exchange Commission, Investor Bulletin: Interest Rate Risk (June 2013) - the inverse relationship between market rates and fixed-rate bond prices, the worked ten-year $1,000 bond at a 3 per cent coupon repricing to about $1,082 on a fall to 2 per cent and about $925 on a rise to 4 per cent, the statement that a lower-coupon bond generally experiences a greater decrease in value as rates rise, the statement that longer maturity means greater risk that value is affected before maturity, and the statement that a government guarantee covers timely interest and repayment of principal at maturity but not the market price if the bond is sold beforehand
- Office of the Comptroller of the Currency, Comptroller's Handbook: Interest Rate Risk, Appendix F Glossary - the definitions of Macaulay duration as the weighted average time until cash flows are received measured in years, modified duration as the approximate percentage price change for a 100 basis point yield change assuming unchanged cash flows, and convexity as the rate at which duration changes with respect to changes in rates
- FINRA, Brush Up on Bonds: Interest Rate Changes and Duration (19 September 2024) - duration as a signal of how much a bond's price is likely to fluctuate rather than a time measure, the rule of thumb that a bond moves in the opposite direction by an amount equal to its duration number for each percentage point change in rates with the ten-year duration worked example, and the relationships that a higher coupon lowers duration and a longer maturity raises it
- ASIC MoneySmart, Bonds - that exchange-traded Treasury Bonds give fixed interest payments and exchange-traded Treasury Indexed Bonds give interest payments linked to inflation, that listed Australian Government Bonds are bought and sold at market value with brokerage payable, that market value may be below face value if sold before maturity because of interest rate movements, that corporate bonds typically require minimum purchases around $500,000 and trade over the counter with retail offerings rare, and that most retail investors access bonds through managed funds
- Australian Office of Financial Management, Treasury Bonds - that Treasury Bonds are medium to long-term debt securities carrying an annual rate of interest fixed over the life of the security and payable semi-annually
- Australian Office of Financial Management, Treasury Indexed Bonds - that the capital value is adjusted for movements in the consumer price index, that interest is paid quarterly at a fixed rate on the adjusted capital value, and that investors receive the adjusted capital value at maturity
Not financial advice, and not a recommendation of any product or institution. Reviewed by the Tradergy editorial team, September 2026.
Common questions
Why do long term bonds fall more when rates rise?
Because more of their value sits further in the future, so a change in the discount rate applies over more years. The Reserve Bank puts the investor's side of it plainly: bonds with a longer term are more exposed to the uncertainty that interest rates or inflation could rise, and if that happens the price of a long-term bond will fall, which is why investors usually demand a higher yield to hold them.
What does duration measure?
Price sensitivity, not time, despite being quoted in years. Modified duration is defined by the Office of the Comptroller of the Currency as the approximate percentage change in a bond's price for a 100 basis point change in yield, assuming the bond's expected cash flows do not change. Macaulay duration is the weighted average time until cash flows are received, and is measured in years.
Does the coupon affect how much a bond moves?
Yes. The lower the coupon, the higher the duration and the larger the price movement for a given yield change. The United States Securities and Exchange Commission states that where two bonds are otherwise identical, the one with the lower coupon rate will generally experience a greater decrease in value as market rates rise.
What is convexity?
The rate at which duration itself changes as yields change. Because it is positive for an ordinary bond, the price gain from a fall in yields is slightly larger than the price loss from an equal rise. Duration alone is a straight-line approximation, and convexity is the correction that matters more as the yield move gets larger.
Does a government guarantee protect me from this?
No. The guarantee covers timely interest payments and repayment of the face value at maturity. The Securities and Exchange Commission is explicit that a government does not guarantee the market price or value of a bond sold before it matures. Interest rate risk applies to government bonds exactly as it does to any other fixed-rate bond.