Convexity

(noun)

As interest rates change, the price does not change linearly, but rather is a convex function of interest rates. Convexity is a measure of the curvature of how the price of a bond changes as the interest rate changes. Specifically, duration can be formulated as the first derivative of the price function of the bond with respect to the interest rate in question, and the convexity as the second derivative.

Related Terms

  • Yield to maturity

Examples of Convexity in the following topics:

  • Duration

    • For large yield changes convexity can be added to improve the performance of the duration.
    • A more important use of convexity is that it measures the sensitivity of duration to yield changes.
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