What does the "C" represent in the convexity formula?

In the context of the convexity formula, "C" stands for the convexity measure itself. Convexity is a financial concept that allows investors to understand how the duration of a bond changes as interest rates change. It provides a second-order measure of how the price of a bond will increase or decrease when interest rates fluctuate, thereby accounting for the curvature in the price-yield relationship of bonds.

Convexity is an important characteristic because it demonstrates that the price of a bond does not change linearly with yield changes; instead, the rate of change in the bond’s price accelerates as yields move away from the coupon rate. The higher the convexity of a bond, the more favorable the changes in price are when interest rates change.

Emphasizing its significance, the convexity measure is crucial for managing interest rate risk, as it helps to better predict the impact of rate changes on bond portfolios. Thus, understanding and calculating convexity allows investors to gauge the potential benefit of holding bonds, particularly in volatile interest rate environments.