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CFA Level I · CFA Level I Exam · Curve-Based and Empirical Fixed-Income Risk Measures

Compared with an otherwise identical option-free bond, a callable bond is most likely to exhibit effective convexity that is:

A callable bond most likely shows negative effective convexity when yields fall to levels where the call option is near the money. The call price caps price appreciation, so the price-yield curve bends downward, unlike the positive convexity of an option-free bond.

  1. Anegative when yields fall to levels at which the call option is near the moneyCorrect
  2. Balways greater than that of the option-free bond
  3. Cthe same as the option-free bond at all yield levels

Explanation

When yields fall and the issuer is likely to call, the bond's price is capped near the call price, so price gains slow as yields fall. This produces negative effective convexity. The option-free bond always has positive convexity, so the callable bond's convexity is lower, not greater or equal.

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