A:

In the bond market, convexity refers to the relationship between price and yield. When graphed, this relationship is non-linear and forms a long-sloping U-shaped curve. A bond with a high-degree of convexity will experience relatively dramatic fluctuations when interest rates move.

While there is no bond convexity function in Microsoft Excel, it can be approximated through a multi-variable formula.

Simplifying Convexity Formulas

The standard convexity formula involves a time series of cash flows and rather complicated calculus. This cannot be easily replicated in Excel, so a simpler formula is necessary:

Convexity = ((P+) + (P-) - (2Po)) / (2 x ((Po)(change in Y)²)))

Where (P+) is the bond price when the interest rate is decremented, (P-) is the bond price when the interest rate is incremented, (Po) is the current bond price and the "change in Y" is the change in interest rate represented in decimal form. "Change in Y" can also be described as the bond's effective duration.

This may not seem simple on the surface, but this is the easiest formula to use in Excel.

How to Calculate Convexity in Excel

To calculate convexity in Excel, begin by designating a different pair of cells for each of the variables identified in the formula. The first cell acts as the title (P+, P-, Po and Effective Duration), and the second carries the price, which is information you have to gather or calculate from another source.

Suppose that (Po) value is in cell C2, (P+) is in C3 and (P-) is in C4. The effective duration is in cell B5.

In a separate cell, enter the following formula: =(C3 + C4 - 2*C2)/(2*C2*(B5^2))

This should provide the effective convexity for the bond. A higher result means that the price is more sensitive to changes in interest rates.

RELATED FAQS
  1. What is the formula for calculating return on equity (ROE) in Excel?

    Find out more about return on equity, the formula to calculate it and how to calculate return on equity in Microsoft Excel. Read Answer >>
  2. How to calculate a bond's modified duration with Excel

    Understand more about the modified duration in fixed income securities and discover how to calculate a bond's modified Macaulay ... Read Answer >>
  3. What is the formula for calculating the capital asset pricing model (CAPM) in Excel?

    Find out more about the capital asset pricing model (CAPM) and the formula for calculating it in Microsoft Excel. Read Answer >>
  4. How do I calculate the equity risk premium in Excel?

    Find out how to calculate the equity risk premium for an individual security using Microsoft Excel, including how to estimate ... Read Answer >>
Related Articles
  1. Investing

    Treasuries Rout May Deepen on Mortgage Hedging

    Fed rate hikes may spur mortage bond owners to sell Treasuries to reduce their exposure to rising rates
  2. Trading

    Improve your investing with Excel

    Find out how to use Excel, a useful tool for assisting with investment organizations and evaluations.
  3. Investing

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  4. Investing

    Understanding Interest Rates, Inflation And Bonds

    Get to know the relationships that determine a bond's price and its payout.
  5. Investing

    Guide To Excel For Finance

    Formulas, functions and features you need to know when using Excel for financial analysis.
  6. Small Business

    The Importance of Excel in Business

    Microsoft Excel is an indispensable tool for any business.
  7. Investing

    How Rising Interest Rates and Inflation Affect Bonds

    Understand bonds better with these four basic factors.
RELATED TERMS
  1. Negative Convexity

    Negative convexity occurs when the shape of a bond's yield curve ...
  2. Convexity

    Convexity is a measure of the curvature in the relationship between ...
  3. P-Test

    A P-test is a statistical method used to assess one or more hypotheses ...
  4. Effective Duration

    Effective duration is a calculation for bonds with embedded options ...
  5. Regulation P

    Regulation P is one of the regulations which addresses standards ...
  6. Key Rate Duration

    Key rate duration is a measure of the sensitivity of a security ...
Trading Center