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CMA Final · Strategic Financial Management · Risks in Financial Market

Kaveri Ltd's bond portfolio has a modified duration of 6 and convexity of 80. Yields rise by 1% (0.01). Using the duration-plus-convexity approximation, change in price % = -D x dy + 0.5 x C x dy squared, what is the approximate percentage price change?

The approximate price change is -5.60%. Duration alone gives -6.00%, and the convexity adjustment adds back 0.5 times 80 times 0.0001, which is 0.40%, because convexity cushions losses when yields rise.

  1. A-6.00%
  2. B-5.60%Correct
  3. C-6.40%
  4. D-5.96%

Explanation

Duration effect = -6 x 1% = -6.00%. Convexity effect = 0.5 x 80 x (0.01)^2 = 0.004 = +0.40%. Net = -5.60%. -6.40% subtracts the convexity term; -6.00% ignores convexity.

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