Question

Relative to interest rates, bond prices have:

		an inverse and linear relationship.
		a direct and linear relationship.
		an inverse and convex relationship.
		an inverse and concave relationship.

Answer 1

Relative to Interest Rate, Bond Prices have an :

Inverse and Convex Relationship

"As interest rate fall, Bond prices rise. Conversely, rising market interest rate leads to falling Bond prices. This opposite reaction is because, as the interest rate rises, the bond may fall behind in the earnings they may offer to the potential investor as compared to other securities. For example, if an investor holds a bond offering 2% interest rate and the interest rate in market rises above 2%, so logically every investor would like to sell of there exisiting holding and invest in higher yielding bond. So as the sell off begins, bond prices begins to fall, and hence there is an inverse relationship.

Convexity is the measure of curvature in the relationship between bond prices and bond yields. If a Bond's duration increases as yields increases, the Bond is said to have negative convexity, and if bonds duration rises and yields fall, bond is said to have positive convexity"