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Understanding Duration and Convexity

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  • Understanding Duration and Convexity

    I'm reading through the convexity and duration material in ASM right now, and its the first time ive been exposed to this stuff, so its not completely clear yet.

    I understand that duration can also be defined as the price sensitivity to a change in interest rates. So does this mean that the number you get for the duration tells you the average weighted time until cash flows occur AND how much the price changes for a 1 percentage point change in interest rates? Is this the correct interpretation?

    And in terms of convexity, the book states that it is "the curvature of the price/yield curve". Again, same question here.. when you solve for the convexity, what exactly is the number telling you? What does it mean when it's negative? And how do duration and convexity react to changes in yield rates?

    I know thats a lot of questions, but any help explaining these concepts in simple terms would awesome. Thanks!

  • #2
    Originally posted by canada324 View Post
    I'm reading through the convexity and duration material in ASM right now, and its the first time ive been exposed to this stuff, so its not completely clear yet.

    I understand that duration can also be defined as the price sensitivity to a change in interest rates. So does this mean that the number you get for the duration tells you the average weighted time until cash flows occur AND how much the price changes for a 1 percentage point change in interest rates? Is this the correct interpretation?

    And in terms of convexity, the book states that it is "the curvature of the price/yield curve". Again, same question here.. when you solve for the convexity, what exactly is the number telling you? What does it mean when it's negative? And how do duration and convexity react to changes in yield rates?

    I know thats a lot of questions, but any help explaining these concepts in simple terms would awesome. Thanks!
    Have you read the wikipedia entries on these topics? I find that some concepts are well explained by it.

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