Question

What are advantages of high duration or negative convexity for a firm to invest in securities?

Answer 1

As the yield on a bond changes so too does its duration, a bond’s convexity measures the sensitivity of a bond’s duration to changes in yield. Duration is an imperfect way of measuring a bond’s price change, as it indicates that this change is linear in nature when in fact it exhibits a sloped or “convex” shape.

Bonds can also have negative convexity, which would indicate that duration rises as yields increase and can work against as well as in favour of investor’s interest. Advantages of high duration or negative convexity are

1.negative convexity, most likely, will imply that bond has embedded option. i.e. bond holder sells call option to bond issuer. therefore you'll have negative gamma position = collect option premium and short volatility.

2.if a bond has negative convexity, its duration would increase.

3.the investor will get his or her money back faster than anticipated

4.if rates were to rise, bonds with negative convexity would be more likely to increase in price—or lose less—than bonds with positive convexity, because there is less risk they will be called or paid off early..