Convexity
Convexity measures the curvature in the relationship between bond prices and yields, refining duration's linear approximation.
Concept map
Learn, apply, review
Use case
Used in fixed income workflows, analysis, and technical interviews.
Judgment check
Useful only when the assumptions and inputs behind the metric are understood.
Deep dive
How to think about Convexity
Duration assumes a linear price-yield relationship, but the actual relationship is curved (convex). Positive convexity means bond prices rise more when yields fall than they fall when yields rise by the same amount — favorable for investors. Higher convexity is valuable, especially in volatile rate environments.
Rank-ready answer
Definition, example, and interview framing
Convexity measures the curvature in the relationship between bond prices and yields, refining duration's linear approximation.
Two bonds have same duration of 10 years. Bond A has high convexity. If yields fall 2%, Bond A gains 22%; if yields rise 2%, Bond A loses 18%. Bond B (low convexity) gains 20% and loses 20% symmetrically. Convexity provides asymmetric upside.
In an interview, define Convexity, explain where it appears in a real finance workflow, then name one assumption or limitation that a reviewer should check.
FAQ
Frequently Asked Questions
What is Convexity?
Convexity measures the curvature in the relationship between bond prices and yields, refining duration's linear approximation.
How is Convexity used in finance?
Duration assumes a linear price-yield relationship, but the actual relationship is curved (convex). Positive convexity means bond prices rise more when yields fall than they fall when yields rise by the same amount — favorable for investors. Higher convexity is valuable, especially in volatile rate environments.
Can you give an example of Convexity?
Two bonds have same duration of 10 years. Bond A has high convexity. If yields fall 2%, Bond A gains 22%; if yields rise 2%, Bond A loses 18%. Bond B (low convexity) gains 20% and loses 20% symmetrically. Convexity provides asymmetric upside.