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FRM Part I · FRM Exam Part I · Applying Duration, Convexity, and DV01

A fixed-rate, option-free bond is priced over a wide range of yields. Which statement about its price-yield relationship is correct?

The price of an option-free bond falls as yield rises, and the curve is convex. So a yield decline of a given size raises the price by more than an equal yield increase lowers it. This asymmetry is the effect of positive convexity.

  1. APrice is a linear, decreasing function of yield, so equal yield changes cause equal price changes.
  2. BFor the same size of yield move, a yield decrease raises the price by more than a yield increase lowers it.Correct
  3. CFor the same size of yield move, a yield increase lowers the price by more than a yield decrease raises it.
  4. DPrice is an increasing, convex function of yield.

Explanation

The price-yield curve of an option-free bond is decreasing and convex (positive convexity). Because of this curvature, a yield fall of a given size produces a larger price gain than the price loss from an equal yield rise. Option C reverses the asymmetry, which would imply negative convexity.

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