CFA Practice Question

CFA Practice Question

Callable bonds have ______ convexity because as rates decline, price increases at a slower rate and eventually does not change at all.
A. positive
B. backwards
C. negative
Explanation: Convexity is the term used to describe the price-yield change for a callable/non-callable bond. At yields below y* (crossover) where the bond is likely to be called (i.e. bought back by the issuing entity), the price-yield change will be negative-convex, i.e. decrease in yield will lead to less and less decrease in price. In other words, as the likelihood of the call option being exercised increases, investors are no longer willing to pay a premium for the bond.

User Contributed Comments 5

User Comment
vadklim I'll keep it in mind in the following way: the negative convexity pools the price down in the same direction as declining % rates.
JohnnyWu But the entire curve is not negative...
dipu617 Thanks vadklim...
bidisha They should attach these qs to Los so we can refer back , like the review ones.
farhan92 i visualised the graph on this but got positive and negative mixed up -.-
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