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CFA Level I · CFA Level I Exam · Interest Rate Risk and Return

A bond is priced at 100.00. If yield-to-maturity falls 25 bps the price is 101.80, and if it rises 25 bps the price is 98.30. Approximate effective convexity is closest to:

Approximate convexity is about 160. The numerator is 101.80 + 98.30 - 2 x 100 = 0.10, and the denominator is 100 x 0.0025 squared = 0.000625. Dividing gives 160, which reflects the curvature of the price-yield relationship.

  1. A80
  2. B160Correct
  3. C320

Explanation

Approximate convexity = (PV- + PV+ - 2 PV0) / (PV0 x Δy^2) = (101.80 + 98.30 - 200) / (100 x 0.0025^2) = 0.10 / 0.000625 = 160. Using Δy of 0.005 would give 40, and omitting the squared term gives other wrong values.

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