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Answer: convexity effect.
## Explanation The asymmetrical price change described in the question is a classic example of **convexity effect** in bond pricing. **Key Concepts:** 1. **Duration**: Measures the linear relationship between bond price changes and interest rate changes. With an 8-year duration, we would expect: - For a 100 bps increase: Price decline ≈ 8.0% - For a 100 bps decrease: Price increase ≈ 8.0% 2. **Actual Price Changes Given:** - Rate increase (100 bps): Price declines by 7.9% (less than 8.0%) - Rate decrease (100 bps): Price increases by 8.2% (more than 8.0%) 3. **Convexity Effect:** - Convexity measures the curvature in the relationship between bond prices and yields - Positive convexity causes bond prices to rise more when rates fall than they fall when rates rise - This creates an asymmetrical price response to interest rate changes - The bond's price-yield relationship is curved, not linear **Why Other Options Are Incorrect:** - **Coupon Effect**: Refers to how coupon rate affects bond price volatility, not the asymmetrical response described - **Maturity Effect**: Refers to how time to maturity affects bond price volatility, not the asymmetrical response **Conclusion:** The bond exhibits positive convexity, which causes the price to increase more when rates fall (8.2%) than it decreases when rates rise (7.9%) for the same magnitude of rate change. This is the convexity effect.
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The option-free bonds of Argus Corporation have a duration of eight years. When interest rates rise by 100 bps, the bond's price declines by 7.9%. When interest rates fall by 100 bps, however, the price rises by 8.2%. The asymmetrical price change is most likely caused by the:
A
coupon effect.
B
maturity effect.
C
convexity effect.
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