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MANAGING INTEREST RATE RISK: DURATION GAP AND MARKET VALUE OF EQUITY - page 10 / 39

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Effective Duration …used to estimate a securities price sensitivity when the security contains embedded options.

Effective duration is

Where Pi- = price if rates fall, Pi+ = price if rates rise; P0 = initial (current) price; i+ initial market rate plus the increase in rate; i- = initial market rate minus the decrease in rate.

Effective duration compares a security’s estimated price in a falling and rising rate environment.

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