Problem: For a given bond, the duration is 8 and the convexity is 100. For a 60 basis point decrease in yield, what is the approximate percentage price change of the bond?
Answer from Kaplan/Schweser: -(Duration)(ChangeYTM) + (1/2)(Convexity) x (ChangeYTM)^2
=(-8*-.006) + (1/2)(100) x (-.006^2) = 4.98%
Where does the"1/2" come from? I havn’t seen that in any forumulas for the convexity adjustment.
Thanks!
If you haven’t seen it anywhere, then you obviously haven’t read the credit analysis reading; they include it there (but nowhere else). It’s an inconsistency in the CFA Institute curriculum, but you just have to live with it. Use it only on questions related to credit analysis.
Sorry.
Many thanks for the response. Maybe I should edit my post to say, " I cannot remember seeing that formula." Headed to re-read that section. Thanks again.
You’re welcome.
I mention this annoying inconsistency in the article I wrote on convexity: http://financialexamhelp123.com/convexity/.