The term “Convexity” is an extremely important concept in the financial markets and as such, it must be taken into account in the ALM modeling process. In the mortgage market, for example, it refers to the fact that borrowers will exercise their option to refinance when mortgage loan rates decline. This causes the average life of higher rate loans to shorten thus severely limiting the price appreciation that would normally accompany a long-term asset in a period of falling rates. Correspondingly, when rates increase borrowers will exercise their option to do nothing but enjoy their below-market rate. Many such borrowers will postpone moving or relocating to preserve the low rate so this causes mortgage loans to extend their average life. This extension in a rising rate environment causes the market value of mortgage loans to decline much more in value than they would increase in value for a corresponding decrease in interest rates. In other words, for the same change in interest rates up or down, mortgage loans decline much more in value than they increase. The call option embedded in callable bonds has similar market value effects that are described by the term “convexity”.