convexity effect

CFA Level I
#1

Hello all,

Ok my algebra is a little rusty, but is this simply order of operations? Obviously the second equation will get rid of the “-”, and results to a different answer.

#1: One example of convexity effect when YTM declines by 200 BPS, and is negative; [97.3 x (-0.02)2] = 3.89% (this is the correct answer, but they show the original equation to use as the one below…)

vs.

#2: convexity effect = 1/2annual convexity(changeYTM)^2: 1/2 x 97.3 x (-0.02)^2 = .0195 or 1.95%

So I guess my question is… Why are they multiplying -.02 * 2 in the top equation (#1). When the equation given (in #2), states that you need to square the -.02?

Please enlighten me! Thanks!

#2

You should be squaring Δ_y_; if they showed Δ_y_ multiplied by 2, they got it wrong.

I wrote an article on convexity that may be of some help: http://financialexamhelp123.com/convexity/.