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Convexity |
| Measures the curvature of the price/yield relationship of a bond's cash flows for large movements in interest rates. The larger the convexity, the steeper the curvature of the price/yield curve. Although duration is a fairly accurate indicator of a bond's expected price movement for a given change in interest rates, it is not exactly perfect. Further, the accuracy of duration's prediction decreases as the level of interest rate change increases. Convexity calculations can be combined with duration to alleviate this problem and give a better estimate of price changes for large movements in interest rates. |