Convexity

Loading the player...

What is 'Convexity'

Convexity is 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.

 

convexity2.gif

BREAKING DOWN 'Convexity'

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.

RELATED TERMS
  1. Negative Convexity

    When the shape of a bond's yield curve is concave. A bond's convexity ...
  2. Convexity Adjustment

    The change required to be made to a forward interest rate or ...
  3. Bond

    A debt investment in which an investor loans money to an entity ...
  4. Bond Option

    An option contract in which the underlying asset is a bond. Other ...
  5. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  6. Required Yield

    The return a bond must offer in order to be a worthwhile investment. ...
Related Articles
  1. Markets

    Explaining Convexity

    Convexity is the measure of the curve in the relationship between a bond’s price and its yield.
  2. Investing

    Immunization Inoculates Against Interest Rate Risk

    Big-money investors can hedge against bond portfolio losses caused by rate fluctuations.
  3. Markets

    Use Duration And Convexity To Measure Bond Risk

    Find out how this measure can help fixed-income investors manage their portfolios.
  4. Markets

    The Effect of Fed Fund Rate Hikes on Your Bond Portfolio

    Learn how an increase in the federal funds rate may impact a bond portfolio. Read about how investors can use the duration of their portfolio to reduce risk.
  5. Financial Advisor

    Why You Should Avoid Fixating on Bond Duration

    Financial advisors and their clients should then focus on a bond fund’s portfolio rather than relying on any single metric like duration.
  6. Markets

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  7. Markets

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  8. Markets

    Understanding Interest Rates, Inflation And Bonds

    Get to know the relationships that determine a bond's price and its payout.
  9. Managing Wealth

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  10. ETFs & Mutual Funds

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
RELATED FAQS
  1. How is convexity used in risk management?

    Learn how convexity is used for risk management for bond portfolios, and understand the difference between duration and convexity ... Read Answer >>
  2. You currently are holding a portfolio of bonds. Interest rates are expected to increase ...

    The correct answer is c. Bonds with high convexity are less affected by changes in interest rates than bonds with lower convexity. ... Read Answer >>
  3. What is the correlation between a coupon rate and the convexity of a given bond?

    Read about the relationship between the coupon rate of a bond, its yield and its convexity, and why zero-coupon bonds tend ... Read Answer >>
  4. How do I use the principles of convexity to compare bonds?

    Read a brief overview of bond duration and bond convexity and why bondholders should take these into consideration when deciding ... Read Answer >>
  5. How can I calculate convexity in Excel?

    Learn how to approximate the effective convexity of a bond using Microsoft Excel using a modified and simpler version of ... Read Answer >>
  6. How can I calculate convexity in MATLAB?

    Learn about convexity of the bonds and how to calculate it in MATLAB with function "bndconvy" after specifying necessary ... Read Answer >>
Hot Definitions
  1. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  2. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  3. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  4. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  5. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  6. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
Trading Center