Question of the Week

A 7-year, 6% coupon callable bond is currently trading at 96.25.  The result of a backward induction valuation model indicates that if yields were to increase by 25 basis points, the new fair value of the bond would fall to 94.80.  On the other hand, if the yields were to decrease by 25 basis points, the new fair value of the bond would rise to 96.98.  Which of the following would best estimate the effective convexity of this bond?

A) -598
B) -342
C) 342
D) 264

Answer:

The correct answer is: a)