Negative convexity meaning

In debt capital markets and structured finance practice, negative convexity describes securities (typically callable bonds or mortgage‑backed/asset‑backed tranches) whose price rises less when yields fall than it falls when yields rise by an equal amount. The price–yield curve is therefore inward‑bending: as rates decline, upside is capped by calls or prepayments; as rates increase, prices drop more sharply and maturities can extend. This is a descriptive market term rather than one defined in legislation or case law. It is used consistently across England & Wales, Scotland, Northern Ireland and Ireland in transaction documents, legal opinions and prospectus risk factors. Key legal and commercial features: - Usually caused by embedded options (issuer call features, borrower prepayment rights). - Produces contraction risk when rates fall and extension risk when rates rise, affecting effective duration and hedging. - Material to drafting and due diligence in bond issues and securitisations, valuation representations, and interest rate risk disclosures. Practical significance: - Lawyers should ensure clear disclosure of negative convexity and related prepayment/extension risks under the UK Prospectus Regulation and the EU Prospectus Regulation (for Irish offerings). - Relevant to covenants and terms on calls, make‑wholes, prepayment mechanics and hedge arrangements documented under ISDA.