Convexity

When we plot a relationship between yield and intrinsic(market)value(when yield is increasing so mv or

intrinsic value of bond is falling) we will take bond intrinsic or market value at y-axis and yield rate at x
axis, this will be a downward slope but this slope is not a straight line as this indicates that direct and
equal relationship between yield and market value of bond and if straight line relationship, this at some
point will cut x-axis(y-axis cutting x-axis here means that bond market value is zero, however this is not
possible) so when we plot this relationship on graph, this will be a trend slopping downwards but this
slope will not be a straight line rather this will be a curve and this curve will be convex to the origin(0)

And this is what we are trying to find. So rate of change of slope of curve is called convexity.

So if the curve is steep we have higher convexity and if is less steep so convexity has lower value.
So two variables one independent on x-axis and other dependent on y-axis, as dyr on x-axis increases
the iv on y-axis will decline, this will be a downward slope, but not on a straight line but as curve

Curve is convex to origin or has convexity towards origin, and we are to measure this convexity in our
observation. The convexity has been achieved because the relationship between variables was not a
straight line, if it has been a straight line y-axis at some point would have interacted with x-axis
providing that iv=0. Convexity can be measured by the following formula
Where n is number of the year under observation for example if year 2 so n=2 and n+1=3 and pv is the
present value of that very year under observation and divided by V into 1+I whole square where V is
intrinsic or market value of bond and i is desired yield rate.