Suppose You Hold a Bond and Interest Rates Suddenly Rise

question 8

Essay

Suppose you hold a bond and interest rates suddenly rise. Duration says that bond prices will fall a given amount. If Convexity is included in this estimate, will bond prices go above or below what Duration predicts?

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Definitions:

Compounded Semiannually

This process involves the interest being calculated and added to the principal sum twice a year, leading to interest on interest.

Compound Interest

Interest determined on the original amount of a deposit or loan, incorporating all the earned interest from past periods as well.

Compounded Semiannually

A method of calculating interest where the interest is added to the principal twice a year, leading to interest earned on interest.

Compounded Annually

This refers to the process of calculating interest on an investment or loan on a yearly basis, where interest from one year is added to the principal for calculation of interest in the next year.