Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › DURATION
- This topic has 4 replies, 2 voices, and was last updated 9 years ago by John Moffat.
- AuthorPosts
- February 19, 2015 at 5:45 am #229120
I was reading the answer that is included in the new pilot paper answer to question four (the question was phrased as such “Discuss how useful duration is as a measure of the sensitivity of a bond price to changes in interest rates”) which contains this statement:
However, duration is only useful in assessing small changes in interest rates because of convexity. As interest rates increase the price of a bond decreases and vice versa, but this decrease is not proportional for coupon paying bonds, the relationship is non-linear. In fact the relationship between the changes in bond value to changes in interest rates is in the shape of a convex curve to origin, see below.
Please could you explain to me the above paragraph. What’s this convexity thing? I don’t understand. I understand that the duration assumes a linear relationship while in reality it’s non linear, however, aren’t all bond coupon paying bonds? The examiner mentions “coupon paying bonds”. What’s this? Please explain the above paragraph.
Also, this line ” This is because it is an average measure based on the gross redemption yield (yield to maturity)” is elusive. Please explain
February 19, 2015 at 5:45 am #229121Is interest rate the same as yield?
February 19, 2015 at 8:51 am #229147Convexity is simply a long word that means the graph is curved (rather than linear).
Not all bonds pay interest. Zero coupon bonds pay zero interest (but instead have a large premium on redemption).
February 19, 2015 at 11:19 am #229174Thank you. Mr. Moffat. And congratulations on winning the PQ award for 2015
February 19, 2015 at 1:18 pm #229188You are welcome (and thank you very much 🙂 )
- AuthorPosts
- You must be logged in to reply to this topic.