FBE 555 - 9. Fixed Income Duration and Convexity

What does duration measure in bond pricing?

Duration measures a bond's sensitivity to interest rate changes.

How does an increase in a bond's yield affect its price?

An increase in a bond's yield to maturity generally results in a smaller price change compared to a decrease in yield of equal magnitude.

What is the relationship between bond prices and yields?

Bond prices and yields are inversely related.

What type of bonds are more sensitive to interest rate changes?

Prices of long-term bonds tend to be more sensitive than short-term bonds.

How is interest rate risk related to bond maturity?

Interest rate risk is less than proportional to bond maturity.

How does a bond's coupon rate affect interest rate risk?

Interest rate risk is inversely related to the bond’s coupon rate.

What does convexity measure in bonds?

Convexity measures the curvature in the price-yield relationship of a bond.

What happens to price changes as a function of yield to maturity?

Price changes can be graphically represented against changes in yield to maturity.

What is Macaulay's duration?

Macaulay's duration is the weighted average time to a bond's cash flows.

What is the duration of a zero-coupon bond?

The duration of a zero-coupon bond equals its time to maturity.

How does a higher coupon rate affect a bond's duration?

Holding maturity constant, a bond’s duration is lower when the coupon rate is higher.

What is modified duration?

Modified duration is the duration divided by (1 + yield/2).

What happens to bond duration as time to maturity increases?

Holding coupon rate constant, a bond’s duration generally increases with its time to maturity.

How does yield to maturity affect a bond's duration?

Holding other factors constant, lower yield to maturity results in higher bond duration.

What does a higher convexity in a bond indicate?

A bond with higher convexity exhibits greater curvature in its price-yield relationship.

Why do investors favor bonds with higher convexity?

Investors pay higher prices and accept lower yields on bonds with greater convexity due to their asymmetrical price behavior.

What is the formula for convexity?

Convexity = 1/(1+y)^2 * Σ [(1+y)^(-t) * (t^2)] for all cash flows.

How do bonds with high convexity behave when yields fall?

Bonds with high convexity gain more in price when yields fall than they lose when yields rise.

What is the implication of a non-linear relationship between bond prices and yields?

The duration rule is a good approximation only for small changes in bond yields.

What does a steep slope in a price vs. interest rate graph indicate?

A steep slope indicates a higher duration.

How is the price sensitivity of a bond calculated?

Price sensitivity is calculated based on the bond's duration.

Why is convexity always positive?

Convexity is always positive, indicating the bond price will always gain more when yields drop.

What occurs when interest rates are volatile in relation to convexity?

The more volatile interest rates are, the more attractive the convexity of a bond becomes.

What effect does duration have on price change?

Price change is proportional to duration.

What are the implications of convexity in risk assessment for bonds?

Bonds with greater convexity are less risky because they mitigate loss in price more effectively than equivalent losses due to rising yields.