27. Bill Peters is the investment officer of a $60 million pension fund. He has become concerned about the big price swings that have occurred lately in the fund's fixed-income securities. Peters has been told that such price behavior is only natural given the recent behavior of market yields. To deal with the problem, the pension fund's fixed-income money manager keeps track of exposure to price volatility by closely monitoring bond duration. The money manager believes that price volatility can be kept to a reasonable level as long as portfolio duration is maintained at approximately seven to eight years.

Discuss the concepts of duration and convexity and explain how each fits into the price-yield relationship. In the situation described above, explain why the money manager should have used both duration and convexity to monitor the bond portfolio's exposure to price volatility.