Hello there,
Looking into the reasoning of the connection/ equation of why a high coupon bond exhibits negative convexity, whereas a low coupon bond exhibits positive convexity.
Got stuck on that in the practice problems and cannot find an explanation.
Thanks
Are you referring to callable bonds having negative convexity at low interest rates? Just graph it and recognize that when rates get low, the bonds will be called, thus limiting price appreciation.
High coupon bonds are less sensitive to interest rate changes, but they don’t exhibit negative convexity as far as I know.
I thank you…
Yes… I was referring to callable bonds.
Eh…to graph a high coupon callable bond at lower current market yields, the portion of the price/ yield relationsship between the market yield and the coupon rate (on the right end horizontal side of the graph) should be almost parallel higher on the vertical prize axe.
The reasoning is that a bond paying a hight coupon whereas markets, the investors, demanding a lower risk rate should trade at a premium. So you can see visually on the graph that there are less sensitive to interest rates changes.
May you enter into it?
Thx again
Bedee