1215

Which of the following statements best describes the concept of negative convexity in bond prices? As interest rates:

A) fall, the bond's price increases at a decreasing rate.

B) fall, the bond's price increases at an increasing rate.

C) rise, the bond's price decreases at a decreasing rate.

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Negative convexity occurs with bonds that have prepayment/call features. As interest rates fall, the borrower/issuer is more likely to repay/call the bond, which causes the bond’s price to approach a maximum. As such, the bond’s price increases at a decreasing rate as interest rates decrease.

1215

Positive convexity means that:

A) as interest rates change, bond prices will increase at an increasing rate and decrease at a decreasing rate.

B) the graph of a callable bond flattens out as the market value approaches the call price.

C) the price of a fixed-coupon bond is inversely related to changes in interest rates.

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Positive convexity refers to the principle that for a given change in market yields, bond price sensitivity is lowest when market yields are high and highest when market yields are low.

Although the statements that begin, the graph of a callable bond . . . and the price of a fixed-coupon bond . . . are true, they are not the best choices to describe positive convexity.