I have to teach some peers about fixed income but I’m having trouble understanding convexity. Could someone please explain it to me like I’m 5
In: 5
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Basically bond prices and interest rates are inversely related – rising interest rates result in lower bond prices. Duration is a way to measure how changes in interest rates might impact the price of a bond. It is basically a linear relationship, but it’s only an approximation. Convexity is a more accurate way to measure this relationship because it accounts for the fact that duration itself changes as interest rates do.
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