A bond has a convexity of 51.44. What is the approximate percentage price change of the bond due to convexity if rates rise by 150 basis points?
A) 0.71%. B) 0.26%. C) 0.58%.
Your answer: B was incorrect. The correct answer was C) 0.58%.
The convexity effect, or the percentage price change due to convexity, formula is: convexity × (ΔYTM)2. The percentage price change due to convexity is then: (½)(51.44)(0.015)2 = 0.0058. I am just wondering why there is a .5 in front of the formula when the originial formula with duration effect included does not have the .5. Thanks.
The formula for the convexity adjustment in the reading on credit analysis has a ½ in it. The formula in the reading on interest rate risk does not have a ½ in it. To know whether to include the ½ or not, you have to decide whether the question is about credit analysis or interest rate risk. It’s stupid, but that’s the way the CFA curriculum works.
Peripherally, the finance community is divided on whether to include the ½ in the convexity number itself (as in the interest rate risk reading’s formulation) or to exclude it from the convexity number and add it as another factor in the formula (as in the credit analysis reading’s formulation). When you’re reading articles about convexity, make sure you know to which school of thought the author belongs.
Thank you for your help. From the question above how would I tell which school of thought I am dealing with since it does not explicitly say which formula to use?
in schweser’s they say that use one-half times convexity if the question asks for the return impact of a change in spread. Is it helpful to remember this note?
Probs a dumb question but to what does the 1/2 supposedly refer to? Are we dealing with the average of positive and negative impacts as per the convexity effect?