Skip to content

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

A trader holds a long bond portfolio hedged with a short position in another bond so the net DV01 is zero. The long portfolio has higher convexity than the hedge position. Which outcome is most likely after a large instantaneous parallel yield shift?

The hedged position gains for a large shift in either direction. A zero net DV01 removes only first-order exposure, and the net position remains long convexity. The positive second-order term from the yield change squared benefits the position whichever way yields move.

  1. AThe hedged position gains for a large shift in either directionCorrect
  2. BThe hedged position loses for a large shift in either direction
  3. CThe hedged position gains only if yields rise
  4. DThe hedged position is unchanged because DV01 is zero

Explanation

Zero net DV01 removes only the first-order exposure. The net position has positive convexity because the long side has more convexity than the short hedge. The second-order term, 0.5 x net convexity x (change in yield) squared, is positive for any large move up or down.

Did you get it right without looking?

One question tells you little. A timed set on Applying Duration, Convexity, and DV01 shows your real accuracy, how long you take and where you lose marks.

Practise Applying Duration, Convexity, and DV01Free diagnostic mock

More Applying Duration, Convexity, and DV01 questions