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Explain the concepts of duration and convexity.

Explain the concepts of duration and convexity.

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Answer #1

Macaulay’s duration measures the sensitivity of a bond price to changes in interest rate. It is the weighted average maturity of the cash flows of the bond.

Modified duration of a bond is a measure of sensitivity of the bond to changes in interest rate. It measures how the price of a price of a bond in response to a change in interest rates.

Therefore, its an exposure to interest rate risk for a particular bond.

Modified duration is Macaulay’s duration divided by one plus the bond’s yield to maturity.

Convexity measures how a bond’s duration will change in response to a change in yield. So, it is used to measure interest rate risk. It is also used to predict the price of bonds.

n case of any query, kindly comment on the solution.

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