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Convexity Adjustment Formula:
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Convexity Adjustment refers to the modification made to the duration of a bond or fixed-income security to account for changes in interest rates. It provides a more accurate measure of price sensitivity to yield changes by accounting for the curvature in the price-yield relationship.
The calculator uses the Convexity Adjustment formula:
Where:
Explanation: The formula calculates the adjustment needed to account for the non-linear relationship between bond prices and yield changes, providing a more accurate duration measure.
Details: Convexity adjustment is crucial for accurate bond pricing and risk management. It helps investors better understand how bond prices will react to interest rate changes, especially for bonds with embedded options or complex structures.
Tips: Enter Bond's Convexity (positive value) and Change of Yield (as a decimal, e.g., 0.02 for 2%). All values must be valid numerical inputs.
Q1: Why is convexity adjustment important in bond pricing?
A: Convexity adjustment accounts for the curvature in the price-yield relationship, providing a more accurate measure of price sensitivity than duration alone, especially for larger yield changes.
Q2: How does convexity affect bond prices?
A: Positive convexity means bond prices increase more when yields fall than they decrease when yields rise, providing a favorable asymmetric price response.
Q3: When is convexity adjustment most significant?
A: Convexity adjustment becomes more important for bonds with longer maturities, lower coupons, and when dealing with larger yield changes.
Q4: What's the difference between duration and convexity?
A: Duration measures the linear price-yield relationship (first derivative), while convexity measures the curvature (second derivative) of this relationship.
Q5: Can convexity be negative?
A: Yes, some bonds like callable bonds can have negative convexity, where price appreciation is limited when yields fall.