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Answer: Enter into a 10-year pay fixed and receive floating interest rate swap.
The objective is to **reduce exposure to rising interest rates**. A long Treasury note position has **positive duration**: when rates rise, bond prices fall. A **pay-fixed, receive-floating interest rate swap** has the opposite sensitivity of a long fixed-income position and can be used as a hedge against rising rates. In effect, this swap position behaves like a **negative duration** instrument relative to a fixed-rate receiver position. Why the other choices are wrong: - **B. Receive fixed, pay floating**: this increases exposure to rising rates because it has bond-like positive duration. - **C. Long Treasury note futures**: a long futures position also benefits from falling yields / rising bond prices, so it would not hedge the long bond position against rate increases. - **D. Buy a call option on Treasury note futures**: a call gives upside if futures prices rise, which is not the desired hedge against rising rates. Therefore, the best hedge is **A**.
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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