Skip to content

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

For an option-free bond, the relationship between price and yield-to-maturity is convex. Compared with a duration-only estimate, the actual price change following a large yield change is most likely:

The actual price change is larger (more favorable) than the duration-only estimate in both directions. Convexity makes the price-yield curve lie above the tangent line, so duration understates price gains when yields fall and overstates price losses when yields rise.

  1. ASmaller than estimated for a yield increase and larger for a yield decrease
  2. BLarger than estimated for a yield increase and smaller for a yield decrease
  3. CLarger than estimated for both a yield increase and a yield decreaseCorrect

Explanation

The price-yield curve lies above its tangent line, which is the duration-based estimate. So the true price is higher than the duration estimate for both yield rises and yield falls. Duration alone understates the gain when yields fall and overstates the loss when yields rise.

Did you get it right without looking?

One question tells you little. A timed set on Interest Rate Risk and Return shows your real accuracy, how long you take and where you lose marks.

Practise Interest Rate Risk and ReturnFree diagnostic mock

More Interest Rate Risk and Return questions