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Solution To Convexity Question

This document contains calculations to demonstrate convexity using a bond with a face value of $3,000, coupon rate of 6%, and yield of 6%. [1] It first calculates the bond price using the bond pricing formula and duration. [2] It then shows that if yields increase by 200 basis points, the price would fall by $207.91 based on duration alone. [3] It then calculates convexity as 15.87 and shows that accounting for convexity reduces the price change to $198.38, closing the gap versus the original calculation.

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110 views2 pages

Solution To Convexity Question

This document contains calculations to demonstrate convexity using a bond with a face value of $3,000, coupon rate of 6%, and yield of 6%. [1] It first calculates the bond price using the bond pricing formula and duration. [2] It then shows that if yields increase by 200 basis points, the price would fall by $207.91 based on duration alone. [3] It then calculates convexity as 15.87 and shows that accounting for convexity reduces the price change to $198.38, closing the gap versus the original calculation.

Uploaded by

natasha
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Solution to Convexity question

using bond pricing formula

1− (1+ i )−n
P = C[ ] + A(1+ i )−n
i
FV 3,000
C 6% $ 180.00
Y 8%

pv of coupons 596.18
pv of fv 2,205.09
$ 2,801.27

using duration
FV 3,000
C 6% $ 180.00
Y 6%

t cf pvcf t*pvcf
1 180.00 169.81 169.81
2 180.00 160.20 320.40
3 180.00 151.13 453.39
4 3,180.00 2,518.86 10,075.43
3,000.00 11,019.04

D= weighted CF / Market/Present Value


D= 11,019.04/3,000
D= 3.67 yrs

If yield increases by 200 basis points:

= -3.67*[0.02/1.06)]
% change = -0.0693021
price change = $ (207.91)
new price = $ 2,792.09
Difference = $ 2,801.27
$ 2,792.09
$ 9.18

calculating convexity
FV 3,000
C 6% $ 180.00
Y 6%

2 2
Year (t) CFs ($) PVCF ($) t(PVCF) t +t (t + t)(PVCF)
1 180.00 169.81 169.81 2 339.62
2 180.00 160.20 320.40 6 961.20
3 180.00 151.13 453.39 12 1,813.58
4 3,180.00 2,518.86 10,075.43 20 50,377.16
3,000.00 11,019.04 53,491.55

Duration = 3.67 yrs

2 2
PVCF x (1 + r) = 3,000 x (1.06)
3,370.80

53,491.55
3,370.80

= 15.87

bond price after adjusting for convexity

2
% change = -3.67 [0.02 / 1.06] + 0.5(15.87)(0.02 )
% change = -0.06612829

price change = (198.38)


new price = $ 2,801.62

difference = $ 2,801.62
$ 2,801.27
$ 0.34

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