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b. Consider the statement, ‘The conclusion is that the more convex bond outperforms the less convex...

b. Consider the statement, ‘The conclusion is that the more convex bond outperforms the less convex bond…’ [Reading 55 ‘Understanding Fixed Income risks and Returns’, CFA Institute, 2014]. Explain this statement with the help of a diagram. Your answer should include a brief definition of ‘convex’ in this context.

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Answer #1

change in price of bond = -duration * change in yield + f(convexity)

f(convexity) represents a term which is a function on convexity. As it can be seen that the convexity is always a positive addendum. So more convex the bond, the higher the price differential with that of a less convexity. Thus the higher convexity bond will always be worth more than the lower convexity bond

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