Question

Fill in the Blanks:

a.) The shape of the price-yield relationship for standard coupon bonds is referred to as a _________ (concave/convex) relationship. This relationship is not _________ (linear/nonlinear).

b.) Although the prices of standard coupon bonds move in the _________ (same/opposite) direction from the change in yield, the percentage price change _________ (is/is not) the same for all bonds.

c.) For very _________ (small/large) changes in the yield, the percentage price change for a given bond is roughly the same, whether the yield increases or decreases. For _________ (small/large) changes in the yield, the percentage price change is not the same for an increase in the required yield as it is for a decrease in the yield. For a given large change in yields, the percentage price increase is _________ (smaller/greater) than the percentage price decrease.

Answer 1

Bond convexity can be defined as a measure of bond prices to changes in interest rates and the non-linear relationship between them. The prices of coupon bonds of same kind behave in the same manner although their magnitude of price change may not be the same. As the yield increases the price falls, there exists an inverse relationship between the two. For a given amount of major changes in the yieldsof the bond there happens to be an increase in the price which will be more than the decrease in the price. Thereby affecting the percentage of the price changes as well.

So, the correct answers will be as follows-

a.) The shape of the price-yield relationship for standard coupon bonds is referred to as a convex relationship. This relationship is not linear.

b.) Although the prices of standard coupon bonds move in the opposite direction from the change in yield, the percentage price change is not the same for all bonds.

c.) For very small changes in the yield, the percentage price change for a given bond is roughly the same, whether the yield increases or decreases. For large changes in the yield, the percentage price change is not the same for an increase in the required yield as it is for a decrease in the yield. For a given large change in yields, the percentage price increase is greater than the percentage price decrease.