DEFINITION of 'Convexity'

A measure of the curvature in the relationship between bond prices and bond yields that demonstrates how the duration of a bond changes as the interest rate changes. Convexity is used as a risk-management tool, and helps to measure and manage the amount of market risk to which a portfolio of bonds is exposed.



In the example above, Bond A has a higher convexity than Bond B, which means that all else being equal, Bond A will always have a higher price than Bond B as interest rates rise or fall.

As convexity increases, the systemic risk to which the portfolio is exposed increases. As convexity decreases, the exposure to market interest rates decreases and the bond portfolio can be considered hedged. In general, the higher the coupon rate, the lower the convexity (or market risk) of a bond. This is because market rates would have to increase greatly to surpass the coupon on the bond, meaning there is less risk to the investor.

  1. Bond

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  2. Par Value

    The face value of a bond. Par value for a share refers to the ...
  3. Convexity Adjustment

    The change required to be made to a forward interest rate or ...
  4. Discount

    The condition of the price of a bond that is lower than par. ...
  5. Negative Convexity

    When the shape of a bond's yield curve is concave. A bond's convexity ...
  6. Below Par

    A term describing a bond whose price is below the face value ...
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  1. How can I calculate convexity in MATLAB?

    In MATLAB, an investor can compute a bond's convexity by invoking a "bndconvy" function from the financial toolbox and specifying ... Read Full Answer >>
  2. How do I use the principles of convexity to compare bonds?

    Convexity, along with another principle known as duration, is an important consideration when assessing bond risk. All else ... Read Full Answer >>
  3. Can a bond have a negative yield?

    The return a bond provides to an investor is measured by its yield, which is quoted as a percentage. Current yield is a commonly ... Read Full Answer >>
  4. Where can I buy government bonds?

    The type of bond determines where you can purchase it, so you need to decide which type of bond you would like to purchase ... Read Full Answer >>
  5. Can a bond be traded over-the-counter?

    Bonds can be traded over-the-counter (OTC) and, in fact, the majority of corporate bonds that are issued by private and public ... Read Full Answer >>
  6. Are high yield bonds a good investment?

    Bonds are rated according to their risk of default by independent credit rating agencies such as Moody's, Standard & ... Read Full Answer >>

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