What is Convexity?
How Does Convexity Work?
The degree to which a duration, which often is represented visually by a . Convexity describes how much a s duration changes when interest rates change, meaning that investors can learn a ' not just from the direction of the but the curviness of the . Accordingly, convexity helps investors anticipate what happen to the price of a particular if interest rates change.'s price changes when interest rates change is called
Generally, when interest rates fall, loans, which are typically refinanced (and thus paid off early) when interest rates fall. Prepayment repays the and mortgage-backed security investors off early, leaving them stuck with reinvesting their at the market's current lower rates. Just the opposite would happen with that have positive convexity.prices rise. But a with negative convexity loses value when interest rates fall. This is often the case for mortgage-backed securities because they rely on underlying
Why Does Convexity Matter?
Convexity is a price-predicting tool for s 'yield is worth the underlying risk.. It also reveals the interest rate risk of a and helps investors consider whether a
Most callable bond at par also increases as interest rates decrease; therefore, the prices of instruments with negative convexity do not rise as quickly as the prices of noncallable bonds, whose convexity is different.are negatively convex, largely because they can be prepaid. An 's incentive to a