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Understanding interest-rate sensitivity is crucial in the world of finance. It is measured by a fund's average effective duration, which indicates how much the fund will be affected by changes in interest rates. The longer the duration, the more volatile the fund will be. For example, a fund with a duration of 10 years will be twice as sensitive to interest rate shifts as a fund with a five-year duration.
Additionally, duration provides insight into how a fund's net asset value (NAV) will change when interest rates change. For every one percentage point increase in interest rates, a fund with a five-year duration can be expected to lose 5% of its NAV, while a decrease in interest rates would result in a 5% increase in NAV. This information can be valuable in making informed investment decisions.
