The following information relates to Questions 5-8 Melissa Clarke, a recent graduate of Harvard Business School, is a mortgage-backed securities (MBS) portfolio manager at Star Flag Fund. The fund primarily invests in Agency MBS, that is, those issued by US Agencies such as Fannie Mae and Freddie Mac. The fund also uses various interest rate products such as US Treasuries, interest rate futures and interest rate swaps (IRS) to manage the fund's duration, cash flow and market risk. A recent economic crisis has sharply reduced US interest rates, including fixed rates offered on conventional mortgages. The sudden drop in interest rates has sparked a re-financing boom, as US homeowners scrabble to refinance existing mortgages at lower interest rates. Clarke is worried about this development and notices that due to accelerated mortgage prepayments, the portfolio's average duration has contracted from 5.7 years to 4.1 years. Having a lower duration in an environment of falling interest rates will clearly hurt Star Flag Fund's performance. Clarke wants to adjust the portfolio's duration back to its target duration to offset the impact of increased MBS prepayments. Fund information and market data are contained in the table below. USD IRS convention is to quote the fixed rate vs 6-month Libor. Also, assume all US IRS transactions are centrally cleared. Fund size Fund target duration Average duration of Agency MBS Duration of 5y US Treasury 6m USD Libor 5y IRS bid-offer quote 7y IRS bid -offer quote $600 million 5.5 years 3.7 years 4.6 years 1.875% 2.015% to 2.025% 2.125% to 2.140% 1 5. To return the fund's duration back to its target of 5.5 years, Clarke should A. Pay fixed rate and receive floating rate in the 5y IRS swap market B. Pay floating rate and receive fixed rate in the 7y IRS swap market C. Sell 5y US Treasuries and may buy agency MBS 6. Assuming the modified duration of the 5y and 7y swap are 4.25 a 5.75 respectively, find the swap notional needed for each tenor to return the portfolio back to its target duration. A. $198m and $146m respectively B. $227m and $146m respectively C. $198m and $183m respectively