Question

A pension-oriented fund holds callable bonds which exhibit negative convexity as rates fall. When rates dropped 1%, bond price only increased 0.8% instead of the 1.2% you'd expect on positive convexity. What happened and how to respond?

Q: Answer-A pension-oriented fund holds callable bonds which exhibit negative convexity as rates fall. When ra...

Callable bonds limit price upside negative convexity. To reduce mismatch and restore convexity, the fund should sell callable bonds and replace with non-callables or use caps to mitigate imbedded options.

A Reinvest proceeds

B Purchase discount bonds

C Buy interest rate caps

D Sell callable bonds to reduce risk

E No action

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A pension-oriented fund holds callable bonds which exhibit negative convexity as rates fall. When rates dropped 1%, bond price only increased 0.8% instead of the 1.2% you'd expect on positive convexity. What happened and how to respond?

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