November 1998
Intermediate to advanced
220 pages
6h 36m
English
Content preview from Fixed Income and Interest Rate Derivative Analysis
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Chapter
8
Convexity
So far we have managed to avoid explicitly dealing with the fact that
bond prices are nonlinear functions of discount rates. Figure
8.1
shows the
price- (vertical axis) yield (horizontal axis) relationship for 10, 20, and 30
year zero-coupon bonds (annual compounding).
Of course all three lines are downward sloping (higher yields mean lower
bond prices), but this slope is not constant. The line is curved with a bow
downwards.
A
function with this shape is called convex, and this character-
istic of bonds is known as convexity. Convexity is a surprisingly pervasive
factor in the analysis ...
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