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Answer: Take a short position in the futures because rising interest rates lead to declining futures prices.
The correct answer is D: Take a short position in the futures because rising interest rates lead to declining futures prices. This is because when interest rates increase, the present value of future cash flows from bonds decreases, which in turn reduces the price of the bonds. Since bond futures are contracts to buy or sell a bond at a future date at a predetermined price, an increase in interest rates would cause the value of these futures contracts to decline as well. By taking a short position in the bond futures, the German housing corporation can profit from the decrease in futures prices, offsetting potential losses from rising interest rates on their bond investments or liabilities. This strategy aligns with a short hedge, which is used to protect against a decrease in the value of an asset or liability.
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A German housing corporation is seeking to safeguard itself against rising interest rates. To achieve this, the corporation plans to use futures contracts on 10-year German government bonds. Which position should the corporation take in the futures market to effectively hedge against the risk of increasing interest rates, and what is the reasoning behind this strategy?
A
Take a long position in the futures because rising interest rates lead to rising futures prices.
B
Take a long position in the futures because rising interest rates lead to declining futures prices.
C
Take a short position in the futures because rising interest rates lead to rising futures prices.
D
Take a short position in the futures because rising interest rates lead to declining futures prices.
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