## FRM-FMP

anbu.edu
Finance Junkie
Posts: 205
Joined: Mon Feb 04, 2013 3:35 pm

### FRM-FMP

Estimated price changes using only duration tend to:
A) overestimate the increase in price that occurs with a decrease in yield for large changes in yield.
B) underestimate the decrease in price that occurs with an increase in yield for large changes in yield.
C) underestimate the increase in price that occurs with a decrease in yield for large changes in yield.
D) overestimate the increase in price that occurs with a decrease in yield for small changes in yield.

Source schweser
i know that as duration Inc -Yield Inc -price Dec but i dont kno how to apply this in question. Please correct me if i am wrong

content.pristine
Finance Junkie
Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

### FRM-FMP

You need to take Convexity of the bond into account.

vnraghuveer
Good Student
Posts: 20
Joined: Mon Apr 08, 2013 1:36 pm
The total effect of yield curve change on price is ( -ΔY x duration) + (1/2 x Convexity x 〖(ΔY)〗^2 ).
If only duration is used it is simply ( -ΔY x duration), to which the convexity effect always adds a positive quantity. i.e., when, yield decreases, using only duration underestimates the increase in price(because it misses a positive quantity added by convexity effect) and if yield increases, using only duration overestimates the decrease in price