Duration and convexity estimates for bonds without embedded options will not be significantly affected by changing the size of the rate shock from 100 basis points to 50 basis points. However, for bonds with embedded options, the size of the rate shock can have a significant effect on the estimates.
We know from Part 3 that the 2025, 5.85% bond exhibits significant negative convexity, which is consistent with a callable bond. The 2010, 4.75% bond has positive convexity, even when yields are significantly below the coupon rate and the bond is trading at a substantial premium. That suggests the 2010, 4.75% bond has no embedded options.
We would expect that changing the size of the rate shock would have a significant effect on the 2025, 5.85% callable bond, but not on the 4.75% 2010 bond. Therefore, Karstein is correct in her analysis of the 4.75% bond, but not the 5.85% bond |
