How does duration measure interest rate risk?

Duration is a crucial concept in fixed income analysis, particularly in measuring interest rate risk. It quantifies bond price sensitivity to changes in interest rates. Specifically, duration calculates the weighted average time until cash flows are received from a bond, taking into account the present value of those cash flows. When interest rates change, the price of a bond will adjust, and duration provides an estimate of how much that price will change.

For example, a bond with a longer duration will experience a greater price decrease when interest rates rise compared to a bond with a shorter duration. This is because long-duration bonds are more sensitive to changes in interest rates, as their cash flows are further in the future. Therefore, duration essentially serves as a risk measure, indicating how sensitive a bond's price is to shifts in interest rates; the larger the duration, the greater the risk.

The other choices do not accurately describe what duration measures. Credit quality relates to the issuer's ability to repay, while return on investment and maturity date are different aspects of bond characteristics that do not directly pertain to measuring interest rate risk.