Convexity

Definition

Convexity in plain English

Bond prices and interest rates move in opposite directions, but not in a straight line — the relationship curves. Convexity measures how much that line bends. The practical payoff: because of the curve, when rates fall your bond gains a little MORE than a simple estimate predicts, and when rates rise it loses a little LESS — the curve works gently in your favor. Picture a straight ruler laid against a bowl-shaped curve; convexity is the gap between the flat guess and the true curved reality, and higher convexity means a nicer cushion for the bondholder.

Learn these first

• Duration
• Modified duration

Related Principles of Finance terms

• Accrued interest
• Allocation effect
• Basis
• Basis point
• Benchmark
• Bond-equivalent yield (BEY)
• Bootstrapping
• Callable bond
• Clean price
• Comparable company analysis (comps)