Explain key rate duration and what it is used for
The idea
Key rate duration measures a bond's or portfolio's sensitivity to a change in the benchmark yield at one specific maturity, holding the others constant. The set of key rate durations sums approximately to the effective duration, but it decomposes that single figure into where on the curve the exposure sits. This is what makes non-parallel shifts manageable: a manager who knows their portfolio has large exposure at ten years and none at two can hedge a steepening directly rather than discovering after the fact that equal duration did not mean equal risk.
A practice question
What does a key rate duration measure?
- Sensitivity to a change in the benchmark yield at one specific maturity — correct
- Sensitivity to a change in the issuer's credit ratingWhy not: That is spread duration, a different decomposition. Key rate durations concern the benchmark curve.
- The average maturity of a portfolioWhy not: A single summary statistic, which is the kind of aggregate key rate durations exist to break apart.
Each key rate duration isolates one point on the curve, holding all other points fixed. Together they describe the shape of the exposure.
A harder one
What is the approximate relationship between a bond's key rate durations and its effective duration?
- The key rate durations multiply to give effective durationWhy not: They add. Each measures the response to a shift at one point, and a parallel shift moves every point at once.
- They sum approximately to the effective duration — correct
- They are unrelated measuresWhy not: They are a decomposition of the same quantity — the parts and the whole.
A parallel shift is the sum of shifts at every point, so summing the individual sensitivities recovers the aggregate one.
The hardest tier
A portfolio is long five-year bonds and short ten-year bonds with zero net duration. What still threatens it?
- A parallel shift in the curveWhy not: That is the one move zero net duration immunises against — it is what the measure is built to describe.
- A change in the general level of ratesWhy not: The same thing said differently, and equally the move the position is protected from.
- A change in the curve's shape, which moves the two legs by different amounts — correct
Net duration of zero immunises against exactly one kind of move, and a position built from two maturities is exposed to every other kind.
In the app: 9 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →