What is duration and convexity and whats the relationship between them

Question

Accepted Answer

Duration and convexity are measures used in fixed income investing to assess the sensitivity of bond prices to changes in interest rates.

Duration measures the sensitivity of a bond's price to changes in interest rates. It is a weighted average of the times until each cash flow is received, with weights proportional to the present value of the cash flow.
Convexity measures the curvature of the price-yield relationship of a bond. It provides additional information about the bond's price sensitivity beyond what duration can capture.
The relationship between duration and convexity is that they both help investors understand how a bond's price will change in response to changes in interest rates. Duration gives a linear approximation of price changes, while convexity provides a more accurate, nonlinear approximation.
For example, a bond with a longer duration will have a greater price sensitivity to interest rate changes compared to a bond with a shorter duration. However, convexity can help investors better estimate the actual price change due to the curvature of the bond's price-yield relationship.

Top Deutsche Bank Senior Analyst interview questions & answers