hard · Principles of Finance

Which of the following describes the 'negative convexity' behavior often observed in callable bonds as market yields fall significantly below the bond's coupon rate?

1. Negative convexity is only a theoretical concept and does not impact the actual trading price of callable debt.
2. The bond's duration increases rapidly, making the price more sensitive to further yield declines.
3. The price falls even as yields fall, because the call premium is deducted from the bond's market value.
4. The price appreciation is limited because the likelihood of the issuer exercising the call option increases, truncating the bond's upside.

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