Statement 1: For a non callable bonds, duration provides only a linear approximation of bond’ s price changes as interest rate change. Statement 2: Incorporating convexity into the analysis of a non callable bond’s price changes as interest rates change always results in higher bond price estimates than derived by using only the bond’s duration. This is true whether interest rates increase or decrease. A : No No B: No Yes C: Yes Yes D: Yes No IMO C. CFAI says D… Statement 2 wont be true for a callable bond …but it clearly specifies non-callable…so my answer is C… Can anybody explain this ? IMO: only callable bond can have negative convexity adjustment. Wot do u say ?

It is D. Statement 1, true becuase the bond is non callable, therefore no negative convexity and we can assume that there is a linear relationship between interest rates change and price change because there is no cap so we will have a straight line. Statement 2 true also, becuase we only use convexity effect if we have a call embedded with the bond so we can arrive at close approximation of bond price change. Since the bond here is noncalllable, incorporating convexity into the equation will lead to a higher approximation of price change. You do not add convexity effect with non callable. We use only if the bond is callabe becuase at certain point, decrease in interest rates will need lead to increase in bond price becuase there a call price ( no body will pay more than the call price and the issuer will immediatly call the bond) so the we will a negtive a convexity. Look at the chart in the book and you will get the picture.

ssdnola Wrote: ------------------------------------------------------- > It is D. Statement 1, true > > Statement 2 true also, Isn’t it C then ??

yes it is C. sorry i meant to say C. check the errata of CFA curriculum http://www.cfainstitute.org/cfaprog/resources/pdf/L1_Errata.pdf

cool - good link ssdnola - thanks

Thanks… good to know …its C only…