Explanation:
Return impact = −(Modified duration) × Change in spread
= −3.75 × (−0.75%)
= 0.0281 or 2.81%
When a credit spread narrows (i.e., decreases), the bond's price increases. The negative sign in the formula accounts for this inverse relationship: a negative change in spread multiplied by the negative duration factor results in a positive return. Without the convexity adjustment, the return impact is purely based on the duration approximation.
Q.3550 A 4-year semiannual corporate bond with a 3.5% coupon is priced at 104.12. This bond's modified duration and convexity are 3.75 and 45, respectively. The bond's credit spread narrows by 75 bps due to a credit upgrade. What is the estimated return impact without convexity adjustment?
A
1.42%
B
1.59%
C
2.95%
D
2.81%
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