Convexity

CFA Level I
#1

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

#2

C

#3

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

#4

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 .

#5

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?

#6

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?

#7

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?

#8

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

#9

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!!!

#10

Thanks everyone