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Answer: Enter into a 10-year pay fixed and receive floating interest rate swap.
**Correct answer: A — Enter into a 10-year pay fixed and receive floating interest rate swap.** A long position in Treasury Notes is exposed to **rising interest rates**, because higher rates cause bond prices to fall. To hedge that exposure, the manager wants a position that **benefits when rates rise**. A **pay-fixed, receive-floating swap** has **short-duration / anti-bond** characteristics relative to the fixed-rate payer, so it tends to gain when rates increase. That makes it an appropriate hedge for a long bond position. Why the other choices are not correct: - **B. Receive fixed, pay floating**: this is bond-like and would generally **lose** when rates rise. - **C. Long Treasury futures**: a long futures position also tends to **lose** when rates rise. - **D. Buy a call option on Treasury Note futures**: this provides optionality, but it is not the direct hedge implied here and is less effective as a straightforward rate hedge. So the best hedge against rising rates is the **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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