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NEW QUESTION: 1
Which of the following statements regarding duration and a bond's price volatility is (are) correct?
I). Duration is a linear estimate of a bond's price change given an expected change in market interest rates.
II). Duration actually underestimates a bond's price increase and decrease given an expected change in market interest rates.
III). The combined effect of a bond's duration and convexity will be greater than a bond's expected change related to duration alone.
IV). Convexity is an attempt to mitigate the error included with the duration measure.
A I and II
B. I and IV.
C. III and IV.
Explanation: Duration is a linear estimate and the application of convexity is an attempt to remedy the errors related to duration. Duration underestimates the bond price increase when market interest rates decline and overestimates the bond price decline when market interest rates rise. Convexity, which can be either positive or negative, may add or reduce the effective change suggested by duration alone.