What is the formula for convexity?

The correct answer reflects the standard formula for calculating the convexity of a bond. Convexity measures the curvature in the relationship between bond prices and interest rates, allowing investors to assess the sensitivity of the bond's duration to changes in yield.

The formula for convexity involves the use of the Modified Duration (referred to as mac in this case) and takes into account the cash flow (cf yield) associated with the bond. Specifically, the numerator comprises terms including the square of Modified Duration, the duration itself, and any dispersion of the cash flows, all unified under the understanding that these factors contribute to the overall measure of how the price of a bond changes with interest rate movements.

The inclusion of ((1 + cf yield)^2) in the denominator of the formula ensures that the impact of yield changes on bond prices is appropriately squared. This emphasizes the curvature effect of the bond’s price sensitivity due to changes in interest rates, a critical aspect of convexity. As a result, this formula correctly articulates how price changes are influenced by their duration and how this relationship compounds with yield adjustments.

In essence, this option accurately represents how factors like duration and cash flow yield interact in determining the bond's price sensitivity, which is the essence of