For large interest rate shocks and large convexity of a fixed-income security or portfolio:
A)the error will not change compared to smaller interest rate shocks and lower convexity
B)the error will be smaller compared to smaller interest rate shocks and lower convexity
C)the error will be greater compared to smaller interest rate shocks and lower convexity
D)there will be no error as duration measures changes accurately

Question

Quizplus · Accepted Answer

For large interest rate shocks and large convexity, the error in duration measures will be greater. This is because duration measures assume a linear relationship between changes in interest rates and changes in bond prices, but this linear relationship breaks down for securities with high convexity when interest rates change significantly. As a result, duration measures will underestimate the change in bond prices, leading to a greater error in predicting price movements.

For Large Interest Rate Shocks and Large Convexity of a Fixed-Income