Convexity implies that duration predictions:
I. Underestimate the percentage increase in bond price when the yield falls.
II. Underestimate the percentage decrease in bond price when the yield rises.
III. Overestimate the percentage increase in bond price when the yield falls.
IV. Overestimate the percentage decrease in bond price when the yield rises.

Question

Quizplus · Accepted Answer

Convexity implies that the percentage increase in bond price is greater than the percentage decrease in bond price, resulting in longer duration bonds having greater price sensitivity to falling yields than rising yields. This means that duration predictions overestimate the percentage increase in bond price when the yield falls (III) and overestimate the percentage decrease in bond price when the yield rises (IV). Therefore, options I and IV are correct, leading to choice C as the best answer.

Convexity Implies That Duration Predictions