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so i have bought “convexity” (optionality), in this case i think it was cheap. if rates stay where they are my bond is long and my option lasts as long as the bonds do, if rates go low the option is exercised sooner (by the actual borrowers via refinance) to monetize it.
maybe I’m being dumb but aren’t you actually short an option here? as in, if yields go down price goes up but not as much as an equivalent bond with no prepay would (so you have negative convexity)?
the convexity is synthetic because the cashflow you bought at a discount gets called early. so you buy a 10y zero that ends up being a 2y zero. its more call-spread than call but its still convex
it’s FI so its dumb bc the underlying is a curve not a scalar and the effect is synthetic but your 10 becomes a 2 and you can still reinvest in a new 10 so its not short the option because you regain the option by getting the cashflow early. they’re reinvestment risk instruments
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