Impact of YTM Change on Bond Price Using Duration and Convexity

Hard Fixed Income Valuation Duration And Convexity

Imagine that you are analyzing a fixed income security that has a duration of 5 years and a convexity of 50. The yield to maturity (YTM) is currently at 4%. You anticipate that the YTM will increase by 0.5% over the next year. Using the modified duration and convexity of the bond, you want to estimate the percentage change in the price of the bond due to the change in YTM.

Which of the following statements best describes the impact of the change in YTM on the bond's price?

The bond price will decrease by approximately 3.15%. This is calculated by applying the duration effect alone.

The bond price will decrease by approximately 3.75%. This calculation includes both the duration and convexity effects.

The bond price will decrease by approximately 4.25%. This reflects a larger price drop than what is warranted.

Hint

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