Bond convexity.

abbas_sukhsorwala · January 2, 2015, 6:31am

To calculate the return impact of a change in yield spread, why is convexity taken as 1/2?

S2000magician · January 2, 2015, 6:49am

Convexity isn’t taken as ½.

What makes you think that it is?

abbas_sukhsorwala · January 3, 2015, 7:57am

it says so in the formula -> Change in bond price = -annual modified duration (ΔYTM) + 1/2 convexity (ΔYTM)2

cpk123 · January 3, 2015, 4:38pm

if you consider a Δr change in rate on either side of r

Convexity = [P(r-Δr) - P(r+Δr)]/ (2 * P * Δr^2)

or ΔP/(2*P*Δr^2) = Convexity

So ΔP/ P = Δr^2 * Convexity / 2

S2000magician · January 3, 2015, 5:20pm

I see: it’s not that the convexity _ is _ ½; it’s that you multiply the convexity by ½.

I wrote an article about convexity that addresses this: http://financialexamhelp123.com/convexity/