positive convexity

Definition

Property of some bonds that when market interest rates rise their price depreciates at a rate slower than the rate at which their price appreciates when the interest rates fall. On a graph it is seen as a bulging (convex) price/yield curve in which the bond's price at very high and very low yields is greater than the price shown as a straight (tangent) line. All other things being equal, positive convexity increases bond return, therefore investors prefer to hold such bonds. All non-callable (option-free) bonds have positive convexity, and so do most fixed interest rate and maturity date bonds. Putable bonds have greater positive convexity than all other bonds. Mortgage-backed bonds have negative convexity and so do the callable bonds. A pass-through bond can exhibit both positive and negative convexity depending on the current mortgage interest rate compared with the interest rate on the underlying mortgages. Positive convexity and negative convexity, however, are not correct mathematical terms; positive convexity is just convexity, and negative convexity is just concavity.

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