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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 best hedge for exposure to **rising rates**. ### Why - The manager is **long 10-year Treasury Notes**, so the portfolio loses value if **interest rates rise**. - A **pay-fixed swap** generally **increases in value when market rates rise**, because the fixed rate paid becomes less attractive while the floating leg resets upward. - This creates a hedge that offsets losses in the bond position. ### Why the other choices are not correct - **B**: A receive-fixed/pay-floating swap would benefit from falling rates, not rising rates. - **C**: A long position in Treasury futures would generally not hedge the bond’s loss from rising rates in the intended direction. - **D**: A call on futures is not the most direct hedge for this exposure. ### Key takeaway To hedge a **long bond position** against **rising interest rates**, use a hedge that gains when rates rise, such as a **pay-fixed, receive-floating swap**.
Author: Manit Arora
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Q-1. 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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