Answer: Enter into a 10-year pay-fixed and receive-floating interest rate swap.

## Explanation When interest rates rise, the market value of existing fixed-income securities (like 10-year Treasury notes) decreases. The portfolio manager has a **long position** in 10-year Treasury notes, meaning they own these bonds and are exposed to interest rate risk. To hedge against **rising rates**, the manager needs to establish a position that will **gain value when rates rise** to offset the losses on the Treasury notes. ### Analysis of Options: - **Option A: Enter into a 10-year pay-fixed and receive-floating interest rate swap** - In this swap, the portfolio manager pays a fixed rate and receives a floating rate. - When interest rates rise, the floating rate payments increase, creating a **positive cash flow** that offsets the decline in the Treasury notes' value. - This is the **correct hedge** for rising rates. - **Option B: Enter into a 10-year receive-fixed and pay-floating interest rate swap** - This would increase exposure to rising rates, as the manager would be paying higher floating rates while receiving fixed rates. - This would **worsen** the position's risk. - **Option C: Establish a long position in 10-year Treasury note futures** - A long futures position would also lose value when rates rise, as bond prices fall. - This would **increase** rather than reduce the exposure to rising rates. - **Option D: Buy a call option on 10-year Treasury note futures** - A call option gives the right to buy at a fixed price, which benefits when bond prices rise (rates fall). - This would not protect against rising rates and would be costly if rates continue to rise. ### Key Concept: The portfolio manager is effectively **long duration** (sensitive to rising rates). To hedge this, they need to take a **short duration** position. A pay-fixed swap creates negative duration exposure, which offsets the positive duration of the Treasury notes.

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