Hi everyone according to the study guide for ct1, we have to understand 'how convexity and duration may be used to estimate the sensitivity of the value of the CF sequence to a shift in interest rates' After reading the notes, i don't really understand the relationship or the answer to the above ^ Also, it would be great if you could explain if this is right: does having a higher spread (convexity) show that the duration is lower? if so, why? thanks for your help!
also don't understand why as the interest rate decreases, the duration increases? I read that it is because the payments are more weighted to the end of the term but don't understand why! thanks
Duration is like the average time to a payment whereas convexity is like the average spread between the payments. So knowledge about one won't help with the other. If you have a higher duration (=average time) then prices will change more from an interest rate change. You can see this yourself - take a 5 year and a 20 year zero coupon bond of £100 calculate the price at 5% and again at 6% and you'll see the 20 year bond's price is more affected by the interest rate change.
