Assume a portfolio manager created a short interest rate hedge for his/her portfolio. Given this hedge, the manager is
A) essentially eliminating both the downside risk and the upside potential.
B) eliminating the downside risk without hampering the upside potential.
C) partially diminishing the downside risk without impairing the upside potential.
D) eliminating the downside risk and increasing the upside potential.

Question

Quizplus · Accepted Answer

A short interest rate hedge is designed to protect against rising interest rates, which would typically decrease the value of fixed-income investments. By hedging, the manager is essentially locking in current interest rates, thereby eliminating the risk of loss if rates go up (downside risk). However, this also means that if interest rates were to fall, the portfolio would not benefit from the increased value of its holdings that would occur in an unhedged position, thus eliminating the upside potential as well.

Assume a Portfolio Manager Created a Short Interest Rate Hedge