# Convexity

Guys please help me with this question ( explain by yield curve pls) How does the convexity of a bond influence the yield on the bond? All else the same, for a bond with high convexity investors will require: A) a lower yield. B) a higher or lower yield depending on the bond’s duration. C) a higher yield. Thanks

C

Higher convexity = higher risk higher risk = higher potential of loss higher potential of loss = higher need for compensation for risk taking = higher yield

Actually that’s not the correct answer. Even though that’s what I initially think of. You can think of another way: Convexity is beneficial for bond holder, therefore, similar to put embeded option, investor would require a lower yield, or in other words, pay higher price for a advantage .

I’m not sure if this is right or wrong: if you look at convexity price-yield function, you’d see with high convexity, we have lower yield and higher price. ( on the north-west corner) Do you think my logic is right here?

Wouldn’t it be A??.. Positive Convexity is a desirable property, isn’t it? when a bond has higher convexity (positive convexity) an increase in yield would cause a lower price reduction than a bond with lower convexity… And a decrease in yield would increase the prices more than a bond with lower convexity… Could anyone clarify?

I think your logic makes sense. however what trouble me is the two prementioned logic do make sense to me, while in fact they are in conflict. Anyone?

It should be A. Why would higher convexity be associated with higher risk?

Convexity is beneficial for bond holder, therefore, similar to put embeded option, investor would require a lower yield, or in other words, pay higher price for a advantage Correct. Don’t get confused- lower yield means higher price. So they are paying up in price and require a lower yield because CONVEXITY IS YOUR FRIEND!!!

Thanks everyone