Convexity of Bonds is an important topic asked in CA Final SFM, (Strategic Financial Management). Learn everything about the concept and the formulae used to calculate the same.
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Convexity of Bonds - CA Final SFM - Strategic Financial Management
1. CA Nikhil Jobanputra
189
Bond Valuation
Convexity of Bonds
Convexity
Itis known thatwhen interest rate expected by the investor (Desired Yield Rate)
changes, the valueof the bond will also change. The desired yield rate and bond
value are inversely related to each other. Therefore, when desired yield rate
increases the bond valuedeclines and vice-versa. When this inter-relationship is
presented graphically, the outcome will not be a straight line but a curvewhich
will beconvexto the origin.Measuringconvexity is measuringtherate of change
in the slope of this curve.
Convexity =
Σn (n + 1)PV
V (1 + i)2
Where,
n = Number of years
PV = Present value of cash flows at nth
year.
V = Value of Bond
i = Expected Rate of Return