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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 it tends to gain value when interest rates rise, offsetting the loss in market value of the long Treasury Note position. ### Why the other choices are wrong - **B (receive fixed, pay floating)**: This position benefits when rates fall, so it would *increase* exposure to rising rates. - **C (long Treasury Note futures)**: A long futures position also loses when rates rise, so it would not hedge the exposure. - **D (buy a call option on futures)**: A call option can provide protection in some cases, but it is not the direct hedge implied here; the classic hedge for rate risk is the pay-fixed swap. ### Key idea A long fixed-income position has **negative exposure to rising rates**. To hedge that risk, use a position that has the opposite rate sensitivity, such as a **pay-fixed swap** or a **short futures position**.
Author: Manit Arora
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Question-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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