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Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here. |
Convexity measures the curvature or the degree of the curve in the relationship between bond prices and bond yields. It shows how the duration of a bond changes as the yield to maturity changes. This curvature effect means that bond prices do not move in a linear fashion with changes in yields.
Bond prices and interest rates have an inverse relationship. When interest rates rise, bond prices fall, and vice versa. Duration measures a bond's price sensitivity to changes in interest rates. However, duration assumes a linear relationship between bond prices and interest rates, which is not always true.
Convexity captures the curvature of the price-yield relationship. It measures how the duration of a bond changes as interest rates change. Positive convexity means that as interest rates decrease, the bond's duration will increase at a slower rate. Conversely, as interest rates increase, the bond's duration will decrease at a slower rate.
Bonds with higher convexity are more valuable because they protect against interest rate risk better. When interest rates rise, bond prices with higher convexity will fall less than bonds with lower convexity. Convexity is more important for longer-maturity bonds because they are more sensitive to changes in interest rates.
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Learn more about the Market Situation Report written by Tier 1 Alpha. |
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