Question

Zero-coupon bond YTM

A 12.75-year maturity zero-coupon bond selling at a yield to maturity of 8% (effective annual yield) has convexity of 150.3 and modified duration of 11.81 years. A30-year maturity 6% coupon bond making annual coupon payments also selling at a yield to maturity of 8% has nearly identical duration—11.79 years—but considerablyhigher convexity of 231.2.

Compare the performance of the two bonds in the two scenarios, one involving an increase in rates, the other a decrease. Based on the comparative investmentperformance, explain the attraction of convexity.

Do you think it would be possible for two bonds with equal duration but different convexity to be priced initially at the same yield to maturity if the yields on bothbonds always increased or decreased by equal amounts, as in this example? Would anyone be willing to buy the bond with lower convexity under these circumstances?

Solutions

Expert Solution
A 12.75-year maturity zero-coupon bond
answered by: Caitlin


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