Estimating Bond Price Change Using Duration and Convexity

Duration is a measure of the sensitivity of a bond's price to changes in interest rates. It represents the weighted average time to receive the bond's cash flows. The concept of convexity complements duration by measuring the curvature in the relationship between bond prices and interest rates. Understanding how these two measures impact bond valuation is crucial for fixed income investors.

Consider a fixed-rate bond with a duration of 5 years and a convexity of 40. If interest rates increase by 1%, what will be the approximate percentage change in the bond’s price? Use the duration and convexity formulas to calculate the approximate price change.