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t. e. In finance, bond convexity is a measure of the non-linear relationship of bond prices to changes in interest rates, and is defined as the second derivative of the price of the bond with respect to interest rates (duration is the first derivative). In general, the higher the duration, the more sensitive the bond price is to the change in ...
Duration (finance) In finance, the duration of a financial asset that consists of fixed cash flows, such as a bond, is the weighted average of the times until those fixed cash flows are received. When the price of an asset is considered as a function of yield, duration also measures the price sensitivity to yield, the rate of change of price ...
Convexity (finance) In mathematical finance, convexity refers to non-linearities in a financial model. In other words, if the price of an underlying variable changes, the price of an output does not change linearly, but depends on the second derivative (or, loosely speaking, higher-order terms) of the modeling function.
Bond convexity is one of the most basic and widely used forms of convexity in finance. For a bond with an embedded option, the standard yield to maturity based calculations here do not consider how changes in interest rates will alter the cash flows due to option exercise. To address this, effective duration and effective convexity are
While compact, effective duration only measures the effect of a parallel shift in the yield curve across all maturities. It does not take into effect other risk factors, such as non-parallel yield curve shifts, convexity, option-adjusted spreads, and others. However, effective duration may suffice for many managers as a basic risk measure.
In mathematical finance, the Black–Derman–Toy model (BDT) is a popular short-rate model used in the pricing of bond options, swaptions and other interest rate derivatives; see Lattice model (finance) § Interest rate derivatives. It is a one-factor model; that is, a single stochastic factor—the short rate—determines the future evolution ...
Duration gap. In Finance, and accounting, and particularly in asset and liability management (ALM), the duration gap is the difference between the duration - i.e. the average maturity - of assets and liabilities held by a financial entity. [1] A related approach is to see the "duration gap" as the difference in the price sensitivity of interest ...
It has found applications in financial management of pension funds, insurance companies, banks and savings and loan associations. Immunization can be accomplished by several methods, including cash flow matching, duration matching, and volatility and convexity matching. It can also be accomplished by trading in bond forwards, futures, or options.