hard · Principles of Finance valuation
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?
- Negative convexity is only a theoretical concept and does not impact the actual trading price of callable debt.
- The bond's duration increases rapidly, making the price more sensitive to further yield declines.
- The price falls even as yields fall, because the call premium is deducted from the bond's market value.
- 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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