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Answer: An interest rate swap paying fixed and receiving LIBOR plus a spread
C is correct. In order to change the interest rate exposure by taking a position with negative duration, the manager will need to invest in securities that decrease in value as interest rates fall (and increase in value as interest rates rise). An interest rate swap paying fixed and receiving LIBOR plus a spread will increase in value as interest rates rise. A is incorrect. Although the call feature of a callable bond decreases the bond's duration in comparison to an otherwise identical option-free bond, the overall duration of the bond remains positive. B is incorrect. Similarly to a callable bond, the duration of a putable bond remains positive despite being lower than that of an otherwise identical option-free bond. D is incorrect. An interest rate swap paying LIBOR plus a spread and receiving fixed will decrease in value as interest rates rise.
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A hedge fund manager managing a portfolio that is highly sensitive to interest rate fluctuations has received an economist's report predicting a substantial shift in interest rates. To mitigate the risk posed by these anticipated changes, the manager aims to adjust the portfolio's exposure to interest rates by incorporating fixed-income securities with a negative duration. Which investment position should the manager take to achieve this adjustment?
A
A long position in a callable corporate bond
B
A long position in a putable corporate bond
C
An interest rate swap paying fixed and receiving LIBOR plus a spread
D
An interest rate swap paying LIBOR plus a spread and receiving fixed
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