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Answer: Enter into a 10-year pay fixed and receive floating interest rate swap.
A **pay-fixed, receive-floating interest rate swap** is the appropriate hedge because the portfolio is **long duration**: it benefits when rates fall and loses value when rates rise. A pay-fixed swap has value that generally **increases when market interest rates rise**, which helps offset the loss in the Treasury Note position. Why the other choices are wrong: - **B** receive-fixed/pay-floating would add exposure to rising rates rather than hedge it. - **C** a long Treasury Note futures position is also exposed to interest rate risk in a way that does not directly hedge the existing long bond position against rising rates. - **D** a call on Treasury Note futures is not the best direct hedge for this interest-rate exposure. So the correct hedge is **A**.
Author: Manit Arora
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GARP 2010.P1.12. The yield curve is upward sloping, and a portfolio manager has a long position in 10-year Treasury Notes funded through overnight repurchase agreements. The risk manager is concerned with the risk that market rates may increase further and reduce the market value of the position. What hedge could be put on to reduce the position’s exposure to rising rates?
A
Enter into a 10-year pay fixed and receive floating interest rate swap.
B
Enter into a 10-year receive fixed and pay floating interest rate swap.
C
Establish a long position in 10-year Treasury Note futures.
D
Buy a call option on 10-year Treasury Note futures.
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