"Fixed Income":Convexity effect

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Questions 1:

The value of a 10-year, 6% coupon, $100 par value bond with semiannual payments, assuming an annual discount rate of 7%, is closest to:

A 、$99.07.

B 、$92.89.

C 、$107.44.

Questions 2:

The option-free bonds of Argus Corporation have a duration of eight years. When interest rates rise by 100 bps, the bond’s price declines by 7.9%. When interest rates fall by 100 bps, however, the price rises by 8.2%. The asymmetrical price change is most likely caused by the:

A 、coupon effect.

B 、maturity effect.

C、 convexity effect.

View answer resolution

【Answer to question 1】B

【analysis】

B is correct. A security with 19 semiannual payments of $3 interest and a 20th payment of $103 (interest plus return of face value) with a semiannual discount rate of 3.5% is computed as:

Fixed Income:Convexity effect

A is incorrect because it is equal to $106/1.07.

C is incorrect because it reverses the coupon rate and the discount rate.

【Answer to question 2】C

【analysis】

C is correct. A fall in interest rates will result in a higher percentage rise in the bond’s price compared with the percentage fall in the bond’s price when interest rates rise by the same amount.

A is incorrect because the coupon effect relates to the sensitivity of bond price changes to changes in the coupon rate.

B is incorrect because the maturity effect relates to the sensitivity of bond price changes to the time to maturity.

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