2013 AM Q8 - convexity

Higher convexity means a larger price increase when interest rates drop and a smaller price decrease when interest rates rise.

Question’s Convexity Asset > Liability.

When interest rate up

Asset value fall less vs. Liability


Surplus up.

Am I correct?


^guidline answers and explanations

I think so, yes.

During the exam scratch the diagram (value - interest rate) with two different convexities. It should take less than 10 seconds!

Yes, a bond with higher positive convexity will be less affected by interest rate than bond with lower convexity. So, in case of question, price decrease for liaibility will be more than price decrease of asset. So surplus increases.

when you say asset drop lower you mean they fall less in absolute value than liabilities or drop further as in more than the liabilities? Semantics matter

^ Good point. I should avoid that on exam day. Thanks a lot. (Revised the original post)