As the US Federal Reserve lays the verbal groundwork for an eventual real-world quantitative easing taper, bond prices are dropping at an accelerated rate. In order to understand the ramifications of a Federal Reserve taper on the prices of a bond or bond portfolio, what is needed is a bond convexity primer.
Observant readers will have noted that various sell-side researchers and other market commentators have mentioned “convexity hedging” as something that could exacerbate a selloff in UST rates. Here I take a high-level look at what convexity hedging is and how it affects the UST market.
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